Whether your retirement is decades away or right around the corner, it’s never too late (or too early) to be thinking about your financial plan. 

Contributing to your 401(k) now is an excellent way to create the retirement lifestyle you want in the future. And with the new cost-of-living adjustments, you can contribute more than ever to this tax-friendly account!

A quick refresher on how 401(k) accounts work

A 401(k) is a pre-tax retirement savings account, or in the case of a Roth 401(k), a post-tax retirement savings account offered by many employers. To participate in the plan, employees sign up to have a specific percentage or dollar amount of their income held back by the employer, and sent directly to their retirement account. At many companies, these pre-tax dollars are even matched by the employer. Most often, 401(k) funds are invested in mutual funds. 

A 401(k) is a huge benefit to employees for two main reasons. First, every contribution to a pre-tax retirement plan lowers your taxable income. That can add up to significant tax savings every year on top of your investment growth, essentially stretching every single dollar you save. Secondly, the money in your 401(k) grows tax-deferred. In fact, you won’t owe any tax on your 401(k) funds until you begin to withdraw that money in retirement. 

Why we advise our clients to max out this specific benefit

In 2022, you can contribute up to $20,500 to your 401(k). For employees over 50 years old, that cap is $27,000. The qualified compensation limit (the maximum amount of compensation that can be considered for contributions and deductions) for 2022 is $305,000. This limit can impact employees differently, based on how their plan is written.

While you can put your retirement savings into other kinds of accounts, like brokerage or savings accounts, the tax savings offered by a 401(k) might just offset any potential gains you’d earn from choosing other investments. Plus, if you put this money in a brokerage account, you’d have to pay tax on your dividends and any gains if you sold the investments. With a 401(k), all those dividends just roll back into the account tax-deferred, creating powerful compounding growth.

 As Aaron Taylor, EA says, 

“A retirement contribution is the only time you get a deduction on your taxes while keeping the money in your pocket.”

At Cook Wealth, we generally advise our clients to max out this specific retirement benefit because it helps them fully capitalize on all their employment situation has to offer. Plus, the annual contribution limits are higher on a 401(k) than an IRA, for example. So it just makes good financial sense to use that higher threshold (with few limitations) instead of trying to make a deductible IRA work for you. 

If contributing $20K to your 401(k) isn’t possible, at least try to max out your employer matching. If your employer will match your contributions up to 4% of your annual salary, for example, do your very best to contribute that full 4%. Otherwise, you’re leaving free money on the table. 

That’s a lot of big numbers, but here’s the bottom line: by contributing as much as possible to your 401(k), you can save yourself some serious tax dollars and take advantage of compound interest. 

Struggling to save enough for retirement? 

The best thing you can do for your long-term financial help is evaluate your financial priorities. If you’re still far away from retirement, it can be especially tough to sacrifice your limited income today. But with a purposeful plan, a clear goal, and celebratory milestones along the way, you can live comfortably now and in the future. When we say we’re on a mission to help you live life empowered, we mean it! 

One more note on 401(k)s… be aware of the True Up Provision

For many employees, getting the most out of their 401(k) is fairly straightforward. Just contribute the full allowable amount every year, if possible. At least earn your full employer matching, if a max-out isn’t realistic. But at some companies, other factors can make maxing out your 401(k) benefits complicated. 

If your employer offers contribution matching, do they have a True Up provision in place? If not, you could be missing out on hundreds or thousands of dollars every year. 

When you max-out your 401(k) allowance early in the year or vary your contribution level from period to period, you may not be earning the full employer matching amount you’re eligible for. This is because at some companies, employer matching is calculated on a per-pay-period basis, instead of being based on your year-end contribution totals. In any pay period where you didn’t contribute enough to earn the full matching percentage, you’ll miss out on that money. 

Companies that have a True Up provision may still calculate their matching contributions on a per-pay-period basis. But at the end of the year they review your total compensation and contributions to make sure you didn’t miss out on any matching. 

Even if your company does not have this valuable provision, talk with your Cook Wealth advisor about how to make sure you’re contributing strategically to max out your 401(k) matching benefit.