Three 401(k) tax tips for 2023

Money Talk

By Rodney A. Brooks

The tax filing deadline is coming at us fast. Hopefully, most of us have already filed and are sitting home waiting for that refund. But that doesn’t mean you shouldn’t start thinking about how to reduce taxes in the future.

One of the best ways to reduce your taxes now or in the future is to contribute to a 401(k) or a 403(b). Here are three 401(k) tax tips for people of all ages, but they are especially relevant for Millennials and Gen Z’ers.

If you work for a company that offers a 401(k) plan, make sure you participate. If you can, contribute 10 percent of your salary. If you can’t afford to contribute the full 10 percent, then contribute at least up to the company match, which is usually about 4 percent of your salary. That 4 percent is what financial people call free money.

Using a Bankrate.com compound interest calculator: For this example, let’s start with $1,000 in your 401(k) account beginning at the age of 30 and contribute 10 percent of your salary. Assume a salary of $45,000 and an employer match of 4 percent. If you retire at 65 and you’ll have nearly $900,000 saved.

If your employer offers a 401(k) you should see if they offer a Roth option. If they do, you should consider putting half of your monthly contribution in the traditional 401(k) and half in the Roth.

Here’s the difference. A traditional 401(k) is tax-deferred, which means you don’t pay federal taxes on the money that goes into the account. But you must pay the taxes on your account once you begin withdrawals.

When you contribute to a Roth 401(k) the money is taxed before it goes in the account. That means that not only do you not have to pay taxes when you make withdrawals, but the money grows in the account tax free.

Let’s use that $900,000 we talked about in the compound interest calculator as an example. When you reach 65 and begin withdrawals from a traditional IRA, depending on your tax bracket you may lose a third or more of that cash to taxes. If it was in a Roth, you get to keep the entire $900,000.

If you can’t afford to contribute to your company’s 401(k) because of crippling student loan debt, there’s still good news courtesy of President Joe Biden. But you must still sign up for the plan.

The Secure Act 2.0, signed into law by President Biden late last year, contained a provision that did not get a lot of press coverage. Here’s how