How Taxes, 401(k) Plans And IRAs Work

Taxes, 401(k) plans and individual retirement accounts, or IRAs, are complicated. If you can master the fundamentals of your personal taxes and understand your retirement savings options, you’ll be able to make informed decisions about your future.

The IRS estimates the average taxpayer spends 12 hours working on their taxes and pays an average of $230 to get their paperwork filed.

“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.”

However, tax experts 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.”

Retirement plans can impact your annual taxes. Until the 1980s, most Americans planned for retirement through pensions. They were defined-benefit plans, in which employers saved on workers’ behalf and 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.

401(k) and other defined-contribution plans like it quickly replaced traditional pension plans. Unlike traditional pensions, 401(k) plans are defined-contribution plans. Employers create a retirement plan in which their 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 U.S. Bureau of Labor Statistics.

In 2020, there were about 600,000 401(k) plans, with approximately 60 million Americans participating in them. The 401(k) continues to be one of the most popular retirement savings options for U.S. 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.

Watch the video above to learn about taxes, IRAs and 401(k) plans.

SEGMENTS:
00:00 - Why Taxes Are So Confusing In The U.S. (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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How Taxes, 401(k) Plans And IRAs Work

[caseybills]

Really enjoyed this video. I'm considering your advice, because thousands of dollars have been disappearing from my 401k due to soaring inflation, and my concern is where to safeguard and grow remaining cash about $500k+ for the next 2-3 years at no risk. I'd love to retire early and afford a life after retirement.

[kortyEdna]

I am 53 and retired at 50. 1 thing I did do to retire early was to get out of the 401K and IRA programs. Bought rental real-estate and I am now a Limited Partner in about 1500+ units from collabrative efforts in the fund my estate planner has me invested in. I do not work.

[HersderaNilers]

Concerns about a potential recession and the Fed's talk of interest rate hikes have left me uneasy. I'm unsure about my $440K portfolio strategy, considering the uncertainty of a recession and the possibility that interest rates may not rise significantly

[HugoBergmann-lund]

Investing in Roth IRA can be a good choice since they are funded with after tax dollars, your contributions can grow tax-free over time. When you withdraw money from your Roth IRA in retirement, you won’t have to pay tax on it, which will help you keep more of your hard-earned money. I retired with 5 million dollars

[bartoszdobroslaw]

Nobody can become financially successful over night. They put in background work but we tend to see the finished part. Fear is a dangerous component, hindering us from taking bold steps we need in other to reach our goals.

[fredrickconte]

You might not have a hundred million dollars to invest, but that doesn’t mean your money can’t share in the same opportunities available to others. You work hard for your money; make sure your money works hard for you.

[ClementRusso]

As I approach retirement, ensuring the stability of my 401k after the turbulent year of 2022 is a top priority. I've come across stories of investors achieving up to $270k in ROI during this current declining market. Any advice on enhancing my ROI before retirement would be highly valued.

[mulattodavid]

Just discovered your channel with this video -- I was able to think about my situation and I'm curious to know best how people split their pay, how much of it goes into savings, spendings or investments, I earn around $90K per year but nothing to show for it yet.

[donaldwatson]

Today's inflation is a result of corporate avarice, not only problems with the supply chain. We know that the money obtained by the higher prices isn't being transmitted along the supply chain since businesses are reporting record profits. More pricing result in increased revenue for businesses, which stays with them and goes into their pockets. We can rule out supply-related inflation because of this. If your stocks are extremely weak, now is an excellent opportunity to take a battered 401k and convert it to a Roth. Then, your Roth will be tax-free, and you will just have to pay taxes on the substantially reduced current values.

[ivymaddison]

My inheritance, a whooping 1m has grown only 4.72% in the past 12 months. In this bear environment does investing w/ a brokerge account under a custodian outperform a 401k? should I seek a pro to grow my funds on brokerage or still hold? I have 5 years to retirement. Happy to discuss.

[Raymondjohn]

High prices for everything have severely affected my plan. I'm concerned if people who went through the 2008 financial crisis had an easier time than I am having now. The stock market is worrying me as my income has decreased, and I fear I won't have enough savings for retirement since I can't contribute as much as before.

[judynewsom]

My concern is my portfolio is struggling, and I'm not sure how a retirement strategy would help in this situation. Making *a million* tax-free sounds like a dream, especially as my stock portfolio is down *30%*

[Braddeman]

I have lost everything I have earned in the market over the last ten years in my 401k just this year. I am down 18%. Thanks to politicians not realizing we can’t just print money with no consequences and it is the middle class that suffered.

[Alystasia]

This sounds so incredibly complicated. Over here the government automatically generates a tax report based on your income of the previous year with the data you provided back then. You then check and correct the form online and you are done.

[NicholasBall]

Biggest financial mistake I ever made was with my 401k. My company had a Roth 401k when my kids were in college, but I didn't actually start contributing until year 3 of the 6 years I had kids in college. Because I was helping them with expenses, I was entitled to the tax credits, so my effective tax rate was extremely low. That is the time you NEED to be in a roth! i still retired with about $350k in my 401k.

[josephlong]

Here's a smart move: retire overseas in a less expensive stable country. Ecuador, Panama, Vietnam, Costa Rica, Malaysia, Indonesia, Portugal are all good spots. A trip to a dematologist that would cost $250-300 in the States costs me $75 for private care here in Costa Rica. Medical insurance with Costa Rica's good socialized medicine system costs me less than $19 a month. Deductibles? None. Co-pay? None. Get outta Dodge, folks.

[claradidi]

The incoming bull run together with the looming recession will be both interesting and exciting!

[TravelingTheWorld]

What I love about the Roth 401(k) is it can help you save on taxes in retirement. Not only are withdrawals tax-free at 59 1/2,  it won't impact the taxation of your Social Security benefit and Medicare premiums.This is an important aspect of a Roth account that most people are not aware of.
yes right now I prefer the Roth 401k! Because I am paying 19% in taxes on my Roth contributions. That is for state and federal combined.

[NPAMike]

I can see my HSA as a 2nd retirement behind my 401k. I like it because i can go over my limit on my 401k through another avenue plus mine has monthly employer contributions.

[christopherboronda]

The tax system is not complex. If you are an adult with access to the internet, you have all the tools to necessary to learn how to do taxes your taxes. I bet everyone here spent more time playing on social media than trying to learn how to save on taxes. The only thing that should be required is adding a tax class to all public education. Probably more important than half of all other schooling