20 IRA and 401(k) Tax Rules You Should Know
Understanding IRA and 401(k) tax rules can help you maximize your retirement savings and avoid costly mistakes.
- Chris Graciano
- 4 min read
Navigating the tax requirements for IRAs and 401(k)s is critical. Knowing these rules might help you save money and avoid fines. This article breaks down 20 critical tax laws that every American should be aware of in order to maximize their retirement plan, including contribution restrictions and necessary withdrawals.
1. Contribution Limits Change Annually
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The IRS adjusts contribution limits for inflation, so checking yearly updates is essential. In 2024, you can contribute up to $23,000 to a 401(k) and $7,000 to an IRA.
2. Catch-Up Contributions for Those 50+
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If you’re 50 or older, the IRS allows extra contributions to boost retirement funds. In 2024, this means an additional $7,500 for 401(k)s and $1,000 for IRAs.
3. Traditional IRA Contributions May Be Tax-Deductible
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Contributions to a traditional IRA can lower your taxable income, but eligibility depends on income and workplace retirement plans. Deductions phase out above certain income levels if covered by a 401(k).
4. Roth IRA Contributions Are Made with After-Tax Dollars
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Unlike traditional IRAs, Roth IRA contributions aren’t tax-deductible. However, withdrawals in retirement are completely tax-free, provided certain conditions are met.
5. 401(k) Contributions Lower Your Taxable Income
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Traditional 401(k) contributions reduce taxable income in the year they are made. This can lower your overall tax burden, making it a smart way to save while cutting your tax bill.
6. Roth 401(k)s Offer Tax-Free Withdrawals
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Contributions to a Roth 401(k) are made after taxes, but qualified withdrawals in retirement are tax-free. This option is ideal for those who expect to be in a higher tax bracket later.
7. Required Minimum Distributions Start at Age 73
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Traditional IRA and 401(k) holders must begin withdrawing at age 73 (previously 72). Failure to withdraw the required amount can result in a hefty 25% penalty.
8. Roth IRAs Have No RMDs
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Unlike traditional retirement accounts, Roth IRAs don’t require minimum distributions. This allows retirees to keep funds growing tax-free indefinitely.
9. Early Withdrawals Before 59½ Trigger Penalties
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Withdrawing from a 401(k) or traditional IRA before age 59½ usually incurs a 10% penalty. There are exceptions, such as disability, medical expenses, and first-time home purchases.
10. Roth IRA Contributions Can Be Withdrawn Anytime
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Unlike traditional accounts, Roth IRA contributions (but not earnings) can be withdrawn anytime without taxes or penalties. This flexibility makes them a great backup emergency fund.
11. Employer 401(k) Matching Is Free Money
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Many employers offer to match a percentage of your 401(k) contributions. Not taking full advantage is leaving money on the table.
12. Rollovers Must Be Done Carefully to Avoid Taxes
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When switching jobs, rolling a 401(k) into an IRA must be done as a direct transfer to avoid taxes. If you receive a check and don’t redeposit within 60 days, it’s treated as a taxable withdrawal.
13. Loans from 401(k)s Come with Risks
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Many plans allow you to borrow from your 401(k), but unpaid loans become taxable if you leave your job. Interest payments return to your account, but you lose out on potential market growth.
14. Non-Spouse Beneficiaries Have to Withdraw Funds Quickly
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Heirs (other than spouses) must fully withdraw inherited IRAs and 401(k)s within 10 years. This change eliminates the ability to “stretch” distributions over a lifetime.
15. Backdoor Roth Conversions Can Bypass Income Limits
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High earners who exceed Roth IRA income limits can still contribute via a backdoor Roth conversion. This involves contributing to a non-deductible traditional IRA and converting it to a Roth.
16. Taxes Apply to Non-Qualified Distributions
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If you withdraw from a retirement account without meeting the age or qualified expense criteria, you’ll owe income taxes and possibly penalties. Planning withdrawals properly prevents costly mistakes.
17. Self-Employed Can Use SEP and Solo 401(k)s
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Business owners and freelancers can set up SEP IRAs or Solo 401(k)s with higher contribution limits. This allows significant tax-deferred savings.
18. IRA Contributions Have an Income Limit for Tax Deductions
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If you have a workplace plan, IRA deduction eligibility phases out at higher income levels. In 2024, the phase-out starts at $77,000 for single filers and $123,000 for joint filers.
19. You Can Convert a Traditional IRA to a Roth Anytime
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A Roth conversion allows moving funds from a traditional IRA to a Roth IRA, but taxes are due on the converted amount. This strategy can be useful in low-income years to minimize future tax burdens.
20. The Saver’s Credit Rewards Low-Income Contributions
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Low- and moderate-income earners can get a tax credit for contributing to retirement accounts. The Saver’s Credit is worth up to $1,000 for individuals or $2,000 for married couples.