The 401(k) plan is considered as one of the best and popular retirement saving vehicle available today. With this plan, an employee makes tax deferred contributions to the 401(k) account where these funds are in turn invested in investment vehicles like stocks, mutual funds, bonds etc. The earnings on these investments are also tax deferred. Hence, the employee’s money grows tax deferred and is taxed only upon withdrawal. However, with so many transactions it can be difficult to understand all the jargon and calculations. Here are some of the basic calculations that one can make regarding their 401(k) account.
Calculating maximum contributions
The calculations for employee contributions are pretty simple. An employee can make pre-tax contributions up to $16,500 if the employee is below the age of 50 and $22,000 if the employee is age 50 and above. Employees can also make after-tax contributions to 401(k) account. But there is a limit to them as well. An employee can make a total contribution (pre-tax + after-tax) of up to $49,000 or 100% of their salary, whichever is less. So, if an employee below the age of 50 makes pre-tax contributions of $16,500, they can make after-tax contributions of up to only $32,500 or 100% of their salary, whichever is less.
Employer’s matching contributions are not counted in these limits; however, employer contributions have a limit as well. Employers cannot contribute more than 6% of the employee’s pre-tax compensation in a year. So, if an employee makes $100,000 annually (pre-tax) the maximum an employer can contribute to their 401(k) is $6,000.
Calculating the percentage of earnings
The performance of one’s plan is mentioned in the annual 401(k) statement one receives. Here is a way to calculate as to how much percentage your funds have grown or in some cases, shrunk.
- Look for, the starting balance, consider this as ‘A’; employee contributions, consider this as ‘B’; employer contributions, consider this ‘C’.
- Add A, B and C to get the total; let’s consider this as ‘D’.
- Look for the ending balance; consider it as ‘E’.
- Subtract D from E to get a new figure. This figure, let’s consider F, is the total gain of the 401(k) account.
- Divide the amount F by D and multiply it by 100. This is the percentage of the growth of the 401(k) account.
Calculating early withdrawal taxes and penalties
Case 1 – If the employee is below the age of 59 ½.
If this employee makes an early withdrawal, the employee has to pay a 10% early withdrawal penalty, 20% withholding tax, federal income tax (according to tax bracket) and state income tax (if applicable).
For example, if an employee in the tax bracket of 28% and state tax of 7% withdraws $10,000, then,
| 10% early withdrawal penalty | $1,000 |
| 20% withholding tax | $2,000 |
| Federal Income tax (28%- 20% = 8%) |
$800 (where the tax is adjusted for 20% withholding tax) |
| State Income Tax (7%) | $700 |
| Total | $4500 |
As one can clearly see that out of the withdrawal of $10,000, one pays heavy taxes of $4,500. Hence early withdrawals are advised against.
Case 2 – If the employee is above the age of 59 ½.
In the same case, where the employee makes a withdrawal of $10,000, the employee won’t be subjected to the 10% early withdrawal penalty, saving the employee $1,000.
One can even make more complex calculations about the future earnings of one’s plan. However, the parameters that have to be considered are varying and fluctuating, hence relying on these calculations is not advised. They should be just used to get a general idea of how much one’s funds will grow in the projected future. Although accepting them, given the present unstable market will be solely at the person’s discretion.
