The government wants to help encourage its citizens to save for things it thinks are beneficial, such as: retirement, healthcare, and college. And one of the ways it does this is by making certain plans and savings vehicles “qualified.”
All that the term “qualified” means is that the savings vehicle is tax advantaged in some way. These include things like Health Savings Accounts, Individual Retirement Accounts, and yes, your employer’s 401k.
So What Kind of Advantage Do I Get for Saving Into My 401k?
Aside from saving money for retirement and letting it grow, you do get other advantages. Money going into a normal 401k goes in pre-tax. This term means that the money going into the account is excluded from income subject to federal income tax.
So the Money Goes in Completely Untaxed?!
But this does not mean that the money is not taxed at all. This only means it is not federally taxed when it initially goes into the account.
The money is still taxed by Social Security, Medicare, State, and local taxes. You only get to exclude this money from your income subject to federal income tax. This distinction is incredibly important to make, however it does not delegitimize how impactful saving into a retirement account can be.
On top of these taxes hitting the contributions to a 401k, the distributions in retirement are then taxed at your federal income tax bracket.
So How Much Can I Save Into My 401k Every Year?
You can save the lesser of your earned income at a given employer or $18,500 for 2018, every year in your 401k. It is important to note that only wages can be saved into a 401k as contributions.
The only other money going into a 401k account can be from rollovers from a different qualified plan, such as an IRA or a 401k or 403b at an old employer.
This article is not intended to be legal, financial, or tax advice. For information regarding your specific situation, please consult a local professional.