Here's everything you need to know about taxes, 401(k) plans and IRAs

Here’s everything you need to know about taxes, 401(k) plans and IRAs

Taxes, 401(k) plans and individual retirement accounts, or IRAs, are complicated. But’s it’s important that you master the fundamentals of both your personal taxes and your retirement-savings options in order to be able to make informed decisions about your future.

Americans don’t spend enough time doing their taxes — on average, just 12 hours along with $230 to file the paperwork, according to IRS estimates — to get the best bang for their buck.

“Your tax return is in no way that simple,” said Mark Steber, chief tax information officer at Jackson Hewitt Tax Service. “I don’t care who you are or what economic situation you’re in — high, medium, low, no income or unemployed.”

In fact, tax experts like Steber say all those IRS tax return forms and schedules are actually designed to help people save money.

“If you have knowledge about how it works, you can utilize the tax code to benefit you more in the long run,” explained Sheneya Wilson, founder of Fola Financial in New York. “However, most people don’t have that knowledge, and I think that is what creates this fear of the IRS and paying taxes, when essentially the tax code is not there to harm anyone.”

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Retirement plans also are a key component of your annual taxes. Until the 1980s, most Americans planned for retirement through pensions, or defined-benefit plans in which employers calculated employees’ retirement benefits based on their years of service and final salary. That changed when Congress passed a new tax code in the Revenue Act of 1978. The act included a new provision in the Internal Revenue Code, Section 401(k), which gave employees a tax-advantaged way to defer compensation from bonuses or stock options .

The 401(k) and other defined-contribution plans have supplanted traditional pension plans over time. Under a 401(k), employers create a retirement plan in which employees can contribute a portion of their wages on a pretax basis, up to an amount determined by the IRS.

From 1980 through 2008, participation in pension plans fell from 38% to 20% of the country’s workforce, while employees covered by defined-contribution plans jumped from 8% to 31%, according to the US Bureau of Labor Statistics.

In 2020, there were about 600,000 401(k) plans, with approximately 60 million Americans participating in them; it is one of the most popular retirement-savings options for US workers.

When people think of retirement savings, in addition to 401(k) plans, IRAs likely come to mind. The key difference is that employers offer 401(k) plans whereas individuals open IRAs. There are pros and cons to both, but if you understand how to contribute and invest those contributions you can maximize your return ahead of your retirement in both a 401(k) and an IRA.

Watch the video above to learn about the fundamentals you need to master to better your financial picture regarding your personal taxes, IRAs and 401(k) plans.

SEGMENTS:

00:00 – Why Taxes Are So Confusing In The US (April 2021)

12:17 – How 401(k) Plans Work And Why They Killed Pensions (March 2021)

24:34 – How IRAs Work And Why They Are More Popular Than 401(k)s (August 2021)

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