Question

9) Eriko earns $45,755 per year. She contributes 8% of her income to her 401(k) plan at work. In her tax bracket, she would pay 37% of her income in state and federal income taxes.

A) How much is she saving this year on her taxes by making these 401(k) plan contributions?

B) Suppose that instead of contributing to her 401(k) plan, she decides instead to deposit the same amount of money to a Roth IRA. What would her tax savings be this year if the money went into the Roth instead?

C) Eriko has projected that her retirement account deposits will have grown to $318,902 by the time she retires. Assuming the same 37% tax rate, what would the after-tax value of her account be if the money is in a 401(k)? In a Roth IRA?

D) Suppose that Eriko’s company offers a 75% match up to 10% of salary, how would this affect her decision of whether to stick with the 401(k) or instead switch to a Roth IRA?

Answer 1

A. 401(K) Plan

• Employees can contribute up to $19,500 to their 401(k) plan for 2020, up $500 from 2019.
• Anyone age 50 or over is eligible for an additional catch-up contribution of $6,000 in 2019 and $6,500 in 2020.
• Employers can contribute too, but there was a $56,000 limit on combined employer and employee contributions for 2019 ($62,000, if eligible for a catch-up contribution).
• In 2020, the combined limit went up to $57,000—$63,500 with the catch-up contribution.
• Employees are already 100% vested in their individual contributions. There may be a vesting schedule for their match.

Her Contribution to the 401(k) plan = $45,755*8% = $3660.4

So Tax savings on Contribution = $3660.4*37% =$1354.35

B.ROTH IRA

Roth IRA contribution limits are $6,000 per year in 2020 and 2019, up from $5,500 in 2018 (people 50 or older can add $1,000 to those amounts). Roth IRA income limits in 2020 are $139,000 of modified adjusted gross income for singles and $206,000 of modified adjusted gross income for joint filers.

Maximum amount of contribution to ROTH IRA= $6000

Her contribution = same amount of 401(k) = 3660.4

So Tax savings on Contribution = $3660.4*37% =$1354.35

C. Withdrawl

Withdrawals from your 401(k) are taxed at your prevailing income-tax rate when you take money out. There are restrictions on how and when you can withdraw money from the account.

If you withdraw funds from a 401(k) before you reach age 59½, you’ll be hit with a 10% early-withdrawal penalty fee as well as any applicable taxes. At age 72, you must begin taking required minimum distributions (RMDs) from the plan. Previously, the RMD was 70½, but following the passage of the Setting Every Community Up For Retirement Enhancement (SECURE) Act in December 2019, the RMD age is now 72

Assuming Eriko withdraws at age 60 then tax would be 37% on $318,902=$117994