Off the Cuff…
Hello everyone, this is Mike Sheehan. I wanted to talk about 401k’s because the question I get a lot from people when I’m helping them or providing them answers or guidance… “Are 401k’s tax deductible?” Most of , could be you depending on your age, but certainly your parents, grandparents had the benefit of what were called pensions that were provided by their employer.
Most pensions have gone away. I mean, I think the only pensions that I, ever hear about are ones that are provided through state employees or federal employees, pension through the government. But most employers now have what are called 401k’s. And I’m going to give you the dictionary benefit or dictionary definition of 401k, a defined contribution tax advantaged retirement savings plan that is sponsored by one’s employer.
All right. So when you start a job, they may walk you into the HR office and say, Hey, we have a 401k. Do you want to participate in that? Most people will say yes. And what that simply means is they’re going to take out a portion. You’re going to determine what that is, a portion. Of your income, your salary, and put it towards a 401k.
The employer is not holding that 401k they’re using an administrator. Just for instance, probably the one that most people know if you looked into 401k administrators is Fidelity. Okay. So they’re the ones that are holding the money, not your employers. So when you leave a employer. That 401k can go with you and that’s a whole other conversation about “rolling over” a 401k.
But the thing about it is you got to ask yourself, do I want to pay my taxes now or do I want to pay my taxes later? And with a 401k, you’re saying , I’m going to take the tax deduction this year and I’m going to pay the tax at the point of starting to take distributions from that, and you can start taking distributions without any kind of penalty at 59 and a half, so 60 years old, and anytime after that, you start to take a distribution from your 401k, you’re going to pay income tax.
Now that’s going to become part of your income. So, let’s say your income is $100,000 and you take $10,000 out of that 401k, your taxable amount that is going to show up as far as the IRS is concerned is $110,000. So again, you have to ask yourself this, and I ask all my clients this in the future, do you figure that taxes are going to go up, stay the same, or go down?
And almost to a client, they’ll say, hey, they’re probably going to go up. So you got to ask yourself, do I want to delay my taxes? Because again, if you’re getting the money with before the taxes are taken that’s a larger amount that is accumulating, but your taxes may be larger too.
So it could be a wash. One of the things that I counsel people on is at this point in your life, 30 years old, 40 years old, 50 years old, You have the most deductions, got your mortgage, you know, probably the three biggest ones mortgage deduction the child deduction and the marital deduction and the child and the mortgage deduction are usually your biggest deductions for a person who is just simply working for an employer.
So you got to ask yourself, do I want to pay the tax now or want to pay in the text in the future because I’ll have less deductions, which means my taxable income is going to be greater. So give you an example, let’s say your mortgage deduction is $10,000. Let’s say the child deduction is $10,000.
And let’s say your IRA or your excuse me, your 401k, which an IRA 401k kind of the same thing. iT’s just delaying the taxes is $10,000. So that’s $30,000. If you put money into a 401k and you subtracted those $30,000, your taxable income is only $70,000. But you go into the future and you don’t have the child deduction, you don’t have the mortgage deduction, you’re still making that same $100,000, and you start to pull some of your money out of that 401k, your amount of tax is going to be greater. So you have to remember that, because some employers will incentivize you by matching your 401k. And what that means is they’ll say we’ll give you 3%, 4%, 5 percent bonus or a matching, not a bonus, but a match. so If you put in five, you know, they’ll put in five, you know, kind of thing.
So you get that which can kind of be looked at as free money. But it also could be something that you could look at, and got to do the math, that this could be what’s paying my tax that I’m going to have to pay, cause you’re not going to get away from that at all.
So you want to do that. So is it tax deductible? Yes. But you need to be aware of the consequences on the other side. So again, some of this can be a little overwhelming, maybe a little confusing. But you need to understand this. You need to understand who is holding the money in your 401k with your employers.
Not the employer. They’re not, the employer is not holding this in their bank account. It’s going to be a separate administrative company that’s going to do that. Probably one of the most familiar ones is Fidelity; they will manage 401k’s for employers. And they’re going to give you options as far as what you can invest in from conservative to risky, so you need to do your homework,
you just don’t want to just let it roll. You know, we’re just going to put that money in there and let them pick. Hey, it’s your money. If the account goes down, that’s loss on your side. No one’s going to make that up. So if you want to have a discussion or talk about this a little bit further, we’re available to you.
Just reach out to us at FinancialProf.org. And we can have that conversation with you and help you out. So until we talk again, make it a great day.
