MAXIMIZING YOUR RETIREMENT CONTRIBUTIONS BEFORE IT'S TOO LATE

November 28, 2023

401(k)

With approximately 600,000 401(k) plans and 60 million active participants, 401(k)s provide an effective way to save for retirement. They offer flexibility in contributions, as eligibility isn't subject to modified adjusted gross income (MAGI) limits. You can set up automatic contributions with your employer, and many employers match a certain percentage of your compensation, which is essentially free money. You should aim to contribute enough to receive the full employer match. For 2023, the maximum employee contribution for a Traditional or Roth 401(k) is $22,500, with a catch-up contribution of $7,500 for those aged 50 and older. For 2024, the limits increase to $23,000 with a catch-up contribution of $7,500.

Some 401(k) plans also allow after-tax contributions, offering two benefits. Earnings grow tax-deferred, similar to pre-tax contributions, and when you leave your job, you can roll over after-tax contributions to a Roth IRA.  This will allow for tax-free growth without required minimum distributions (RMDs) at age 73 or 75. Additionally, some plans permit in-plan conversions for tax-free growth. The total contribution limit for 2023, including pre-tax, Roth, employer match, and after-tax contributions, is $66,000 (excluding catch-up contributions).  It will increase to $69,000 in 2024. Consider these limits when choosing your contribution percentages for the coming year.

Traditional (Pre-Tax) vs. Roth (Tax-Free) 

Deciding between pre-tax and Roth contributions is a significant retirement savings choice. You don't need to consider MAGI for 401(k) contributions, but the right choice depends on your current year's tax rate versus your expected rate in retirement. Your goal is to defer income pre-tax at a higher rate or contribute Roth at a lower current rate. Consider factors like potential tax rate changes, changes in filing status, and expected future taxable income. Consult your advisor to create a financial plan that projects future income and tax rates. Your advisor can also explain the tax benefits of Roth accounts for your beneficiaries upon your passing.

IRA vs. 401(k)

Always contribute enough to your 401(k) to receive the employer match.  If you don’t receive the full match, you could be leaving money on the table. After that, it gets more complex, as 401(k)s typically have higher costs and more restrictions compared to IRAs. Consider factors such as access to funds, minimum distribution requirements, costs, investment options, Roth conversions, penalty-free distributions, and more. Typically, it's best to maximize your 401(k) up to the employer match, then maximize your IRA contributions before contributing more to the 401(k). The exception is if you're ineligible for a deductible or Roth IRA contribution and can't do a tax-free backdoor Roth contribution, in which case you should prioritize the 401(k).

Traditonal IRA vs. Roth IRA

In addition to income tax considerations, there are other factors to consider when choosing between a Traditional IRA and a Roth IRA:

• Confirm your MAGI to determine your eligibility for a deductible Traditional IRA contribution. If your MAGI is too high, consider contributing to a Roth IRA, as it offers tax-free growth for after-tax contributions.
• If you can't contribute to a Roth IRA due to high MAGI, consider making a non-deductible Traditional IRA contribution. If your Traditional, SIMPLE, and SEP IRAs have a $0 balance, you may be eligible for a tax-free backdoor Roth contribution by converting a non-deductible Traditional IRA contribution to a Roth IRA.

This decision matrix provides a comparison of retirement contribution options using 401(k) Traditional, 401(k) Roth, Roth IRA, and Traditional IRA. It can help individuals make informed decisions based on their unique financial circumstances and preferences. Remember to consult with a financial advisor to tailor your retirement plan to your specific needs.

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