Forty years ago, Congress pulled together and approved the Revenue Act of 1978. 401(k)s were simpler back then; they generally had far fewer investment options than are available today, and were meant as supplements to pension plans rather than as standalone tools to largely privatize retirement income. But times have changed. For many of us, the humble 401(k) has morphed into our best hope of retiring in relative comfort.
If you work at a law firm or almost any type of decent-sized company, odds are pretty good that you have access to a 401(k) plan (there are other types of retirement savings plans available to government employees which are essentially the same thing as a 401(k), for instance, the federal Thrift Savings Plan). You might already know the basics, but in case you don’t, the gist is that you put money into your 401(k) account, and you don’t have to pay income tax on that money as you earn it. You don’t have to pay taxes immediately on your investment gains either. Instead, you pay tax on your withdrawals from your 401(k) in retirement. Alternately, you can fund a Roth 401(k), which would mean you pay taxes on your income as you get it, but if you wait to withdraw your investment gains until after age 59½, you pay zero taxes on your withdrawals. If you can afford to pay the income taxes today, Roth 401(k)s are a phenomenally good deal.
Tax savings are the big benefit of 401(k)s, but there are others. You may get matching contributions from your employer up to a certain amount. Law firms often offer particularly generous matches. It’s not just out of the goodness of the partners’ hearts: traditional 401(k)s have complex top-heavy rules which prevent exceptionally high earners at a given organization from tailoring their plans so that they can take advantage of huge tax savings while putting the screws to the low-level employees. But a safe harbor 401(k) plan can help get a firm out of the complicated nondiscrimination tests that apply to traditional 401(k) plans by, among other things, providing for employer contributions that are fully vested when made. While a safe harbor plan doesn’t necessarily mean that the top earners aren’t still getting a way better deal than you, hey, free money is free money. You should take advantage of any company match you can get.
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If your firm doesn’t offer a 401(k), or even if it does but you’re not a Biglaw associate automatically pulling in six figures in your first job, you probably want to start an IRA. Like traditional 401(k)s, traditional IRAs let you defer taxes on your contributions (you can substitute a Roth IRA for a better deal in the long run if you can afford the taxes today). For those not covered by a retirement plan at work (and who do not have a spouse with a retirement plan at work), there is no income limit for taking advantage of an IRA. However, if you are covered by a retirement plan at work, for a single filer, your deduction for traditional IRA contributions starts to phase out at $64,000 in annual income, and disappears completely at $74,000 in annual income. $74,000 is not a terribly hard income to reach for an attorney. But for a Roth IRA, a single person covered by a retirement plan at work can still contribute the full amount to his or her Roth IRA while earning up to $122,000 for 2019 (the phase-out base is much higher for married couples filing jointly). Once again, the Roth is a hugely good deal. For non-Biglaw attorneys, getting to fully fund a Roth IRA is one of the few structural advantages you have to keep (catch?) up with your Biglaw colleagues financially. If you start it early, fully fund it, and make wise investment decisions (I suggest passively managed stock market index funds with low expense ratios), a Roth IRA can make an enormous difference over a lifetime.
On November 1, the IRS publicized its new contribution limits for 2019. Next year, you can contribute $19,000 to your 401(k) (up from $18,500). The annual contribution limit for IRAs is also increasing, from $5,500 to $6,000. If you’re 50 or older, you can made additional catch-up contributions.
So go for it. If you qualify in that Roth sweet spot for income of above $74,000 but below $122,000, or have a spouse whose contribution limit you can piggyback on, I’d love to see you sticking $19,000 after-tax in your Roth 401(k) and another $6,000 in your Roth IRA. Trust me, you will thank yourself later, and you’ll regret making those contributions a lot less than spending that money on whatever superfluous items you were going to buy next year. You went through the higher education system, so I know you have experience living fun on a lot less than what you’d have left after fully funding your retirement. Treat yourself to a decent retirement. Old-you will be happy you did.
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Jonathan Wolf is a litigation associate at a midsize, full-service Minnesota firm. He also teaches as an adjunct writing professor at Mitchell Hamline School of Law, has written for a wide variety of publications, and makes it both his business and his pleasure to be financially and scientifically literate. Any views he expresses are probably pure gold, but are nonetheless solely his own and should not be attributed to any organization with which he is affiliated. He wouldn’t want to share the credit anyway. He can be reached at [email protected].