Must 401K contributions be withheld from pay?

[Guest ctfudge07]

Here's why I'm asking: My husband just started a new job and will be able, starting in mid-summer, to contribute to his company's 401K plan. He intends to get the maximum match, and in fact, possibly contribute the $15,500 that is allowed (as a tax shelter.)

That is a lot of money for six months' worth of pay, and additionally, we should have another source of funds from which we can draw other than pay. Could an employee just make a lump payment of the entire amount before the end of the year and still have that reflected in the W-2?

I realize that it makes most sense to just have it withheld from pay each pay period, and I'm sure that's what he'll do in future years, but this year is different since he just started and since we do have access to the funds at this point to just fund the account all at once. Thanks in advance.

[Guest Pensions in Paradise]

401(k) deferrals must be withheld from pay.

But you should still be able to accomplish your goal. First, check if the plan has a limit on the maximum percentage that can be withheld from pay. If there is no limit, then just have your husband elect to withhold 92% of pay each pay period until he reaches $15,500.

[Guest ctfudge07]

I thought that might we the way we could do it. Is it common to have a maximum amount allowed to have withheld from pay, and if so, is there a customary maximum?

THANK YOU!!

[401_4_ever]

It is common, and there is no customary maximum. Depending on the plan if he is what is known as an HCE (highly compensated employee) he may be forced to withdraw some of the money at the end of the year. An HCE is either a 5% owner or someone who makes over $100,000.

I thought that might we the way we could do it. Is it common to have a maximum amount allowed to have withheld from pay, and if so, is there a customary maximum?

THANK YOU!!

[Guest ctfudge07]

He's neither of those. He'll have to just ask at work. He did mention that there's an option to have 401(k) contributions made pre-tax or post-tax, and I have no idea why anyone would want to do the latter. I bet you guys here probably know all too well, though (everyone on this site seem to know their stuff inside and out.) Thanks again!

[Bill Presson]

He's neither of those. He'll have to just ask at work. He did mention that there's an option to have 401(k) contributions made pre-tax or post-tax, and I have no idea why anyone would want to do the latter. I bet you guys here probably know all too well, though (everyone on this site seem to know their stuff inside and out.) Thanks again!

Before you make a decision on how to defer the money, make sure you know how the match is calculated. If it is based on the entire year, then how much you defer out of each check is irrelevant. But if the match is calculated each payroll, you'll need to spread out the deferrals to get the maximum match.

[Guest ctfudge07]

Thanks very much - I'll check on that.

[Lame Duck]

ctfudge07,

In your other post you mentioned the advantages of a Roth IRA over a traditional IRA. Those same rules apply here. The after tax contributions to the plan could be to a Roth 401(k) feature. This operates in much the same way as the Roth IRA. The contributions are taxable but the gains are tax free when distributed. Over a long period of time, the tax savings on these gains could far outweigh the tax advantage of deductible contributions today. It is something you will want to consider. It might be advisable to split the contributions so that the 6% that is matched is made with tax deductible contributions and the balance with taxable, Roth 401(k) contributions.

For example, assume that you are in a 25% tax bracket. A $15,000 before tax contribution would save you about $3,750 in taxes. At a 5.5% rate of return for 20 years, that $15,000 contribution would grow to approximately $43,700. The tax on this would be $10,925 at a 25% rate. In other words, you are trading a tax deduction of $3,750 today for a tax of $10,925 in the future.

[Guest ctfudge07]

I think I see what you are getting at, and I'm trying hard to compute at which point our tax savings "max out" so that we might as well be putting some of those funds into Roths instead of just filling up the maximum 15,500 contribution allowed to a 401K.

To completely confuse the matter, I'm also trying to figure out where we would be able to use or where we would lose things like the the EIC and the child tax credit, and to really scramble my brain, I know that sometimes very little child tax credit can be taken but "additional tax credit" is computed to be available to use. I am not sure if everyone (under a very high income level which does not apply to us) gets the entire combined child tax credit available, as long as they make enough money. I understand that the EIC (which we'd qualify for if we had low enough AGI) and the Add. Child tax credit are "non-wastable" credits, and can result in a refund even when no tax is due.

You see, our income is 48,000, and if we contribute 15,500 to 401k and 8000 to trad. IRA, we'll owe no tax at all. In fact, we can contribute a fair amount less than that and still owe no tax.

[Guest jims]

Don't forget about the Saver's Credit. It is an additional credit for 401k and IRA contributions available to low income people - even up to $50,000 joint filers. Here is the original announcement - www.irs.gov/pub/irs-drop/a-01-106.pdf Don't worry that it' old. Legislation in 2006 extended it and made the limits indexed to inflation. I don't think the IRS has provided a new updated notice yet. You'll like this a lot since you are a saver.

[Guest ctfudge07]

Wow, I just found out that the match is not guaranteed, but is based on company performance. Has anyone heard of anything like that? I wonder if I might be misunderstanding of if my husband might have misunderstood.

[david rigby]

...the match is not guaranteed, but is based on company performance. Has anyone heard of anything like that?

It used to be more common that the match was based on company earnings, but less common now.

[Guest ctfudge07]

re: saver's credit

I ran a Turbo Tax return (practice, have not filed yet) and a $400 retirement savings credit popped up. I am guessing that must be the saver's credit referred to above.

*oh, by the way, I found out that there is no maximum percentage, and he can contribute up to 100% of pay after deductions, and it's allowable to squeeze a year's worth into six months. The HR person told him that someone else is doing just that.

[Guest ctfudge07]

Question for Lame Duck:

I understand completely what you said about the tax savings today vs. the tax bite tomorrow. I've mulled over this sort of thing quite a bit. Question: Do these Roth IRA options within a 401K (not sure if the husband's company even offers that, he thinks not but I think so based on what he said about post-tax contributions) negate any ability to have a separate Roth IRA? What I mean is: I realize there's a limit (currently $4,000 per each person in a married couple under age 50) that can be contributed each year - this Roth option under a 401K is not in addition to that, is it? We are already planning to contribute the maximum for 2006 and 2007 for each of us to Roth 401Ks. As far as I know, beyond that, the best place to park money (I'm trying to place inheritance money where it can immediately go to work, if you didn't read my thread elsewhere) would be maxing out the 401K. I do feel uneasy about putting so much money each year (it's a lot, to us with our income level) in something tax-deferred, but maybe I should not feel uneasy. My instinct is to prefer paying the tax now and never paying it again - I feel that traditional IRAs are a sort of deal with the devil (when the Roth is an alternative) and I know that 401Ks should not be characterized in that manner, but I admit that I get a little uneasy about them, nonetheless, but tax-deferred is preferable to fully-taxable - or is it? And are there any feasible alternatives? Obviously I'm pretty new to all of this and trying to avoid paying someone to advise me, but I'm not the most mathematically-minded in the whole world (although I'm far from mathematically disabled), so I may have to do just that.

[Lame Duck]

ctfudge07,

I don't claim to be an expert on the Roth 401(k). There are others here who can better advise you than I can. However, I do not believe having a Roth 401(k) will limit your ability to make Roth IRA contributions any more than a traditional 401(k) contribution will limit it.

As you are aware with the Roth IRA, the main advantage of the Roth 401(k) is the ability to contribute taxable money today with the expectation of receiving tax free money in the future. Over a long period of time, the advantages of the tax free savings should far out way the taxes you pay today.

I have been following your other thread with great interest and have been impressed with the insightful questions and observations you've made. The advice you get from the others in this forum is from some of the best minds in the country. I don't think you can go wrong by listening to them.

[401_4_ever]

These questions plague everyone, and generally depend on your current tax bracket, your tax bracket at retirement, how close you are to retirement, how well/poorly you invest the money, and most importantly the unanswered question of whether congress will raise or lower the tax brackets/rates between now and the time you take a distribution, and if you are far from retirement that of course is wholly unpredictable.

Question for Lame Duck:

I understand completely what you said about the tax savings today vs. the tax bite tomorrow. I've mulled over this sort of thing quite a bit. Question: Do these Roth IRA options within a 401K (not sure if the husband's company even offers that, he thinks not but I think so based on what he said about post-tax contributions) negate any ability to have a separate Roth IRA? What I mean is: I realize there's a limit (currently $4,000 per each person in a married couple under age 50) that can be contributed each year - this Roth option under a 401K is not in addition to that, is it? We are already planning to contribute the maximum for 2006 and 2007 for each of us to Roth 401Ks. As far as I know, beyond that, the best place to park money (I'm trying to place inheritance money where it can immediately go to work, if you didn't read my thread elsewhere) would be maxing out the 401K. I do feel uneasy about putting so much money each year (it's a lot, to us with our income level) in something tax-deferred, but maybe I should not feel uneasy. My instinct is to prefer paying the tax now and never paying it again - I feel that traditional IRAs are a sort of deal with the devil (when the Roth is an alternative) and I know that 401Ks should not be characterized in that manner, but I admit that I get a little uneasy about them, nonetheless, but tax-deferred is preferable to fully-taxable - or is it? And are there any feasible alternatives? Obviously I'm pretty new to all of this and trying to avoid paying someone to advise me, but I'm not the most mathematically-minded in the whole world (although I'm far from mathematically disabled), so I may have to do just that.

[Guest ctfudge07]

I seem to be good at asking the hard questions with no easy answers. If this helps, I'll take a stab at some assumptions. We are in a low tax bracket now, but since we are smart, risk-tolerant investors with some prior experience, we expect to invest shrewdly (or maybe I should say aggressively with a lot of insight and effort, and not ultra-safely or with a hand-off set-it-and-forget-it approach as I know some prefer) and hope to make good returns, and hope to be in a higher tax bracket at retirement, and also we are not very close to retirement - I'd say 20-25 years plus is not close.

I can't control for factors such as tax laws being changed and other catastrophes such as disabilty or economy collapse.

Does it help that I've supplied those variables (or rather outlined some gambles/hopes)?

[stephen]

If you feel comfortable that you'll be in a higher tax bracket at retirement you may want to defer most of your contribution as a Roth 401(k) as it will allow you to have tax free withdrawals at retirement as opposed to your pretax withdrawals being taxed at the higher rate than you are cutrrently receiving a deduction for.