|
Cents and Sensibility Guy Steele |
What to do if you’ve
maxed out your 401(k)
contributionIF you participate in a 401(k) plan, you probably already know that it's a great retirement savings vehicle. After all, your pre-tax contributions lower your annual taxable income, your earnings grow tax-deferred and you've got a range of investment options from which to choose. So, it's probably a good idea to contribute the maximum to your 40 1(k), right? That may be true -- but, depending on your situation, you may have to figure out the maximum.
In the financial and investment worlds, few things are as simple as we'd like them to be, and the issue of maximum 401(k) contributions is a perfect example. On one hand, the laws governing 401(k)s limit contributions to a maximum of $13,000 in 2004; if you're 50 or over, you can put in an extra $3,000. However, your employer may only allow you to contribute 6 percent of your salary to your 401(k), and that amount may fall short of the $13,000 ceiling.
Which figure applies? It's the lower one. If the 6 percent limit results in you putting in only $10,000 to your 401(k), then that's what you can contribute. Conversely, if the 6 percent limit meant you could actually put in $17,000 to your 401(k), you'd be limited by the $13,000 cap.
So, what can you do if you reach one of these ceilings and you'd like to put more away? You could try to lobby your company's benefits area to change the rules, but you may not have much success. Companies are often restricted in what they can do by "non-discrimination" laws designed to limit the amount of contributions made by highly paid employees.
Consequently, you're better off looking for other tax-advantaged investments. Start with a traditional or Roth IRA. In 2004, you can put in up to $3,000 to your IRA, with another $500 as a "catch-up" contribution if you're 50 or over. Each type of IRA offers tax advantages: A traditional IRA grows on a tax-deferred basis, while Roth IRA earnings grow totally tax free, provided you meet certain conditions. Furthermore, you can fund your IRA with virtually any type of investment you choose.
After "maxing out" on your 401(k) and IRA, what should you do if you still have money to invest in tax-advantaged vehicles? You may want to consider purchasing a municipal bond, which offers interest payments that are free of federal taxes. Municipal bond interest may also be free of state and local taxes; however, some "munis" may incur the alternative minimum tax. In general, you will achieve the greatest benefit from municipal bonds if you are in one of the highest tax brackets and if the "spread" -- the difference in yield -- between municipal bonds and taxable bonds is relatively small.
You'll almost certainly help yourself a great deal by putting in as much as you can afford to your 401(k). If you can't put in the maximum, contribute what you can. But if you do bump into the 401(k) ceiling, it's nice to know you can find other ways to take your retirement savings to higher levels.
See the Columnists section for some past articles.
Guy Steele is a financial planner and head of the Pali Palms office of Edward Jones. Send planning and investing questions to him at 970 N. Kalaheo Ave., Suite C-210, Kailua, Hawaii, 96734, or call 254-0688