Maximizing Contributions
If your employer offers a 401(k), it’s simple smarts to contribute every payday, but how much?
If your employer matches a portion of your contributions, as many do, the answer is easy. Consider contributing at least enough to get the full match. It’s like getting free money! Withdrawals are taxed as ordinary income and, if taken prior to age 59½, they're subject to a 10% penalty.
Making a match
Let’s say your employer matches 50% of your contribution up to 6% of your total income. That means if you make $50,000 per year and contributed the maximum matched contribution amount of 6%, you would be contributing $3,000. Your employer would put in $1,500, for a total of $4,500.
- Your contribution: $3,000
- Your employer’s 50% match: $1,500
- Your total for 2006: $4,500
If you can go above and beyond your employer’s match limit, more power to you. You might even find that you need to in order to reach your retirement goals. Keep in mind there are yearly limits on how much you can contribute. Currently, the maximums are:
- 2007: $15,500
- 2008: $15,500
- 2009: $16,500
Also keep in mind that there may be a vesting period to receive employer matches. So, if you leave the company before your employer’s match is vested, you have to give that money back.
Are you a late bloomer?
You're not the only one who’s gotten a late start on a 401(k). That’s why there’s a “catch-up” exception to contribution limits shown above. If you're at least 50, you can add an additional $5,000 in 2007 and $500 incremental increases through at least 2009. It’s never too late to start!
Help! You've reached the limit
So, you've maxed out your 401(k), but still have money you want to invest. Lucky you! Many experts suggest a Roth or traditional IRA. Here’s why:
Roth IRA advantages
- Paid for after-tax so withdrawals in retirement may be tax-free
- Can contribute after age 70½
- No minimum age limit — start one for kids or grandkids
- Compounding interest for greater growth possibility
A Roth IRA can be a good compliment to a 401(k). Its tax-free withdrawal status for qualified distributions may help hedge against the risk that you'll be in an undesirably high tax bracket when you start withdrawing from, and paying taxes on, your 401(k) investment.
Roth IRA limitations
In 2001, tax laws increased Roth IRA annual contribution limits through 2008:
- 2005 - 2007: $4,000
- 2008: $5,000
It’s also possible to make too much for a Roth IRA. If you're single and want to make the maximum contribution, your yearly income can't exceed $95,000. If you're married and filing a joint return, your yearly income limit is $150,000.
When you exceed these limitations, the amount you can contribute is gradually reduced and eventually eliminated.
Traditional IRA
A major difference between a traditional IRA and a Roth IRA is tax status. A Roth IRA is paid for after paying taxes on income, while traditional IRA payments are made pre-tax.
Next steps
If your employer offers a 401(k), get enrolled today! If not, talk to your investment professional about an IRA account. Too many people put off retirement planning until they're near retirement, then they scramble to come up with a plan. The sooner you start, the further ahead you'll be.
Keep in mind that all investing involves market risk, including the possible loss of principal. Neither Nationwide nor any of its representatives give legal or tax advice.
