401(k) plans, also known as a retirement savings, are special retirement accounts that permit an employee within a company to allocate a portion of their wages into a long-term investment. When choosing to set up a 401k plan, your employer has the option to match your contribution. Contributions to a Roth or traditional IRA or 401(k) plan will be deducted from your wages each time you are paid. Companies rarely match 100% of the amount that you contribute yearly. Most companies worldwide contribute on an average about 4.3% of your pay towards your retirement account. This contribution is in addition to the percentage you may choose to deduct from your own wages.
When selecting a workplace retirement plan suitable for you, you want to make certain it is a “qualified retirement plan”. Being a qualified retirement plan means that you will be eligible for special tax advantages under strict IRS regulations. There are two different way that a qualified plan can be presented. The plan must be a part of a defined-contribution or a defined benefit plan. A defined-contribution plan is a retirement plan that is completely tax-deferred. An example of a qualified plan would be a 401(k) or a 403(b). Having a defined-contribution plan means that an employee will contribute a fixed percentage of their paycheck to an account that is projected to supplement income after their retirement. In contrast, A defined-benefit plan is an employer-funded retirement plan covered by your workplace directly. Generally, an employee is prohibited from withdrawing funds at the time of retirement, such as with a 401(k) plan. Rather, an employee will be entitled to take their benefit as lifetime pension plans or in special circumstances it will be disbursed as a lump-sum payment. The age that the lifetime pension begins, or lump sum payment is paid out will also be listed in the retirement plan’s guidelines.
A Roth 401(k) or a Roth IRA is funded with after tax dollars. This means when you receive your paycheck you will have the normal taxes withheld and then arrive at your net income. After federal, state and local taxes are withdrawn from your paycheck is when they take the desired percentage and transfer it to your retirement account. When you take withdrawals from the Roth account during your retirement, the withdrawals will be tax free. A traditional 401(k) account is funded with pre tax dollars. This means that the income you make before taxes are taken out, gross income, is where your contribution percentage is taken from. Then your federal, state and local taxes will be withheld afterwards. When you reach retirement and take withdrawals from a traditional 401(k) they will be taxed as income. In 2020, the phase-out range for contributing to a Roth IRA has increased from the prior year. For singles and heads of household, the income phase-out range is $124,000 to $139,000, up from $122,000 to $137,000. For married couples filing jointly, the income phase-out range is $196,000 to $206,000, up from $193,000 to $203,000. For married taxpayers who are filing a separate return, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.
There is a limit to the amount of wages that you, as an employee, can contribute on a yearly basis. These limits have increased for 2020. If you enroll in either a Roth 401(k) or traditional 401(k) account, the contribution limit for 2020 is $19,500. That is an increase of $500 from 2019. Employees aged 50 and older have an additional catch-up contribution limit of up to $6,500. That is an increase of $500 from 2019.
Below you will find a detailed chart of information provided by the Internal Revenue Service. This chart delivers an analysis of how the rules and limits for defined-contribution plans (401(k), 403(b), and most 457 plans) are changing for 2020 vs. 2019. |(Source: IRS Notice 2019-59)
|DEFINED CONTRIBUTION PLAN LIMITS||2019||2020||CHANGE|
|Maximum employee elective deferral||$19,000||$19,500||+$500|
|Employee catch-up contribution (if age 50 or older by year-end)*||$6,000||$6,500||+$500|
|Defined contribution maximum limit, all sources||$56,000||$57,000||+$1,000|
|Defined contribution maximum limit (if age 50 or older by year end); maximum contribution all sources, plus catch-up||$62,000||$63,500||+$1,500|
|Employee compensation limit for calculating contributions||$280,000||$285,000||+$5,000|
|Key employee’s compensation threshold for nondiscrimination testing||$180,000||$180,000||none|
|Highly compensated employees’ threshold for nondiscrimination testing||$125,000||$125,000||none|
Within your workplace there should be a designated employee who handles all payroll and retirement information. This department is known as the Human Resource Department. Your Human Resource Manager should advise all employees, yearly, what their chosen 401(k) contribution limits are. Plan contributions can change from year to year so it is best to be aware what your limits are before the year starts. Not all employees will have the benefit of funding a retirement account to the maximum limit each year. It is best to keep in mind what your contribution limits are and push yourself to increase your percentages contribution in 2020 to utilize the full tax benefits. Keeping in mind the limits to your contribution will ensure that you do not go beyond them. If you reach your annual limit before the year ends then you are at risk of losing all the employer matched contributions per-paycheck unless it is specified in your plan that the employer would be willing to still provide that matched amount even though your surpassed the annual limit allowed. This option is known as a “true up” payment stipulation. For example, most 401(k) and other retirement plans use the per-paycheck method. This means that if your contribution for 2020 is at a rate of 5 percent of your pay, your employer will match the contribution to a certain level. Generally, and as stated above, on average, companies are only matching up to roughly 4 percent. If there are employees who have the availability to contribute higher amounts of their pay, then they are at jeopardy of reaching the annual contribution rate much sooner in the year. By hitting the limit, you are forced to stop contributing to your retirement account and there4fore miss out on the employer matched contribution also. With opting to have the true up option in your retirement plan your employer is making a promise to still make their matched contribution whether or not an employee has hit the annual contribution limit early in the year. Each employer has the option to handle their true-up payments differently. Employers can choose to wait until the year has ended to process the true-up payments or they can make the true-up payments throughout the year and per each paycheck as normal.