With the new year around the corner, there are some things you should examine to keep your 401(k) savings on-track.
Roth or traditional for 2013?
Historically, 401(k) contributions have been pre-tax payroll deductions. Employers deduct money from a paycheck prior to taking taxes out, and the money is placed directly in the employee’s 401(k) plan account. That’s a traditional 401(k) contribution. The advantage of a pre-tax contribution is that it lowers the employee’s taxable income. However, traditional contributions and any investing gains earned from them will be subject to ordinary income tax at the time the money is withdrawn during retirement.
More recently, Roth 401(k) contributions have been popular. Employers deduct money from a paycheck after taking taxes out; Roth contributions and any investing gains earned from them will not be subject to income tax when the money is withdrawn during retirement.
You might want to reconsider how you’re contributing during 2013. If your big-picture goal is to minimize the taxes you pay during your lifetime, you’ll need to consider whether you’ll be in a higher tax bracket now or during retirement. No one knows what the tax code will look like when you retire, although many economists predict incremental increases over time. When you talk to your tax adviser, do some math with him or her to decide how you should contribute in 2013.
Can I increase my 401(k) contributions in 2013?
As you move ever closer to retirement, a relatively low-pain way to save more money is to increase your 401(k) savings rate by 1 percent each year. The goal, of course, is to reach a point where you’re maxing out your 401(k) contribution limit every year, but most Americans can’t just dive in with a maxed-out payroll deduction from day one. Incrementally increasing your rate each year will allow you to adjust your budget by a small amount annually. And putting away just a little more a little earlier could make a big difference when you consider the potential of compounding.
Some employers will automatically increase your contributions for you. Oftentimes you, the employee, must enroll in an auto-increase benefit, but some plans enroll all participants. It’s becoming more common to see an annual auto-increase of 1 percent, though that will vary by plan. Check with your plan administrator to find out whether auto-increase is available and automatic for you.
The maximum salary deferral amount will be increased to $17,500 in 2013. If you are able to save to the maximum amount, review your percentage to ensure you’re taking advantage of this increase.
What should I do with my year-end bonus?
Don’t spend all of it! If you’re going to receive a bonus, you can put that money to good use in 2013. Many employers pay bonuses in December or January, which is perfect timing. If you’re lucky enough to receive a bonus, put it straight into a savings account. Use the funds to give yourself some financial padding that will enable you to make other changes with more confidence—like increasing your 401(k) contributions or increasing debt payments. The extra bump in your savings may also spur you to save more; it’s amazing what a little kick-start can do.
Lastly, 2013 will most likely hold some changes for most Americans where taxes are concerned. If ever there was a time to consult your tax adviser, this is it.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.
Smart401k is not an accounting firm and does not provide tax advice. Nothing in this article should be construed as tax advice and Smart401k does not warranty or guarantee, in any way, the accuracy of any tax-related information contained in this article. Please contact your tax professional to discuss: (1) the amounts and timing of your retirement plan contributions; (2) matters related to charitable and gift giving; (3) the timing of payments made from flexible spending accounts; (4) current and future tax withholdings strategies and requirements; and/or (5) any other tax matters.