During this day and age of expanded life expectancies and a vague outlook on the future of the Social Security program, retirement plans are being emphasized so that individuals will have money to support themselves in the not so distant future. Retirement plans also come with tax benefits depending on the type of plan you choose. A 401(k) is a valuable and beneficial retirement plan that many companies offer their employees. If made available by an employer, anyone can choose to start and contribute to their own 401(k) account. Here is what you need to know when comparing a 401(k) plan to an individual retirement account (IRA):
- A 401(k) plan, as opposed to an IRA, uses pre-tax income, which reduces the amount of gross income that will show up on your tax return. This reduces your tax liability.
- Contributing to your 401(k) is especially simple, as you can typically set it up to be withdrawn directly from your paycheck.
- Compared to an IRA, a 401(k) contribution can be much larger. In 2020, an individual’s yearly 401(k) deduction can be as high as $19,500 for those under the age of 50, or it can be as high as $26,000 for those who were 50 or older. Meanwhile, an IRA can only have a deduction of up to $6,000 or $7,000 if certain requirements are met.
- An IRA contribution deduction is phased out at higher income levels when you go to file your taxes, which is not the case for 401(k) plans. No matter your income level, you will always be able to apply tax deductions with a 401(k).
Generally speaking, it is a great idea to contribute to a 401(k), whether you do it in place of or in addition to an IRA. It is especially beneficial if your employer matches your 401(k) contribution, as that is essentially just free money in your pocket. Most important to note, it is never too early or too late to save for retirement. A 401(k) investment is something that can positively impact not just your tax liability outlook but also your future financial well-being as a whole.
Sam Bloomberg is a Staff Accountant at Arcara Zucarelli Lenda & Associates, CPAs, pc. Sam graduated Magna Cum Laude with BS in Accounting from Medaille, as well as a Master’s Degree in Accounting.