Tax treatment of withdrawals—and the age at which you can and must take withdrawals without penalty—can vary among types of plans as well. A comparison can help you identify which is best for you. Investment gains grow tax-deferred until you withdraw the money in retirement. If you withdraw funds from the plan before age 59 1/2, however, you could pay a 10% penalty, and the withdrawal would be subject to federal and state income taxes. Some plans allow 401(k) loans, however, if you find yourself in a cash emergency. Some employers match their employees’ contributions to a 401(k), typically up to 6%. However, you might not be fully “vested” in your plan for a number of years. That means you wouldn’t be able to take your employer’s contributions with you if you were to leave the company before the prescribed period of time had elapsed. Your own contributions to the plan are always yours, however. If you’re not contributing up to the company match, you could be ignoring a significant employee benefit. That match is effectively free money. Employers who offer these plans are often willing to let you make contributions through automatic payroll deductions, which can make saving easier. Investment choices for these types of plans are often limited, and management and administrative fees can be high. The IRS imposes contribution limits per year, although limits for 401(k) plans are more generous than those for other plans: $20,500 in 2022 (up from $19,500 in 2021). This increases to $26,000 if you’re 50 or older and take advantage of the allowed $6,500 catch-up contribution. You can contribute up to $6,000 in 2022. This increases to $7,000 if you’re age 50 or older. This limit is unchanged from 2021 limits. You’ll pay no taxes annually on investment gains, which helps them to grow more quickly. Many taxpayers can deduct their IRA contributions on their income tax returns if they don’t also have a 401(k) retirement account, which reduces their taxable income for that year. Some restrictions exist based on income. You pay income taxes on the money you contributed and on gains when the money is withdrawn in retirement. You can buy and sell investments within the IRA, but if you try to take money out before you reach age 59 1/2, that is known as an “early distribution,” and you’ll probably have to pay a 10% penalty fee, just as you would with a 401(k). You’ll also be subject to federal and state and income taxes on the withdrawal. You can withdraw contributions you’ve made to a Roth IRA before retirement age without penalty, provided five years have passed since your first contribution. You’re not currently required to begin taking withdrawals at age 72, as you are with traditional IRAs, 401(k)s, and other retirement savings plans. The best part about a Roth 401(k) is that there is no income limit as with a Roth IRA. The annual contributions are the same as a traditional 401(k), too—just with after-tax dollars. Withdrawals are the same as with a Roth IRA as well, but the distribution rules match those of a traditional 401(k). Early distributions can result in a hefty penalty, however. Unless you qualify for an exception, you’ll have to pay an additional 10% tax on the amount you withdraw from your SIMPLE IRA (similar to Traditional IRAs and 401(k) plans). If you make the withdrawal within two years from when you first participated in the SIMPLE IRA plan, this additional tax increases to 25%. You can’t borrow from a SIMPLE IRA, either, the way you can from a 401(k). The maximum annual contribution limits are higher than most other tax-favored retirement accounts: $61,000 for 2022 (up from $58,000 in 2021), or 25% of income— whichever is less.
