401(k) plans

A 401(k) plan allows an employee to choose between receiving compensation in cash or putting some of this cash into a company-sponsored 401(k) plan. Money that is put into the plan is not taxed until it is withdrawn from the plan. Funds contributed to the plan reduce your federal and state taxes as those contributions are subtracted from gross income when filing tax returns.

For example, if you contribute $1,000 and your federal marginal tax rate is 25% and your state tax rate is 5%, you will reduce your federal taxes by $250 and your state taxes by $50.

If you have the option of contributing to such a plan, should you do it? Generally, the answer is yes, but you need to do a little research first.

Your federal taxes

Are you likely to owe any federal taxes based on your income? The 2026 standard deduction for individuals is $16,500. Do a quick search on “2026 income tax brackets”, determine which bracket you fall in, and deduct the standard deduction. If you are not likely to owe federal taxes, then a 401(k) which allows you to defer taxes is not very useful for you from the perspective of saving federal taxes.

Vesting periods

What is the vesting period? A vesting period is the amount of time an employer mandates that you must work for the company before you can leave with the funds your employer has contributed as a match. The shorter the time, the better.

Note the distinction here – you never lose the funds you have contributed, but the vesting period may restrict when you can leave with funds your employer has contributed.

Company matches

Is there a company match, and how exactly is it computed? A match is when your employer contributes a certain amount to your retirement savings plan based on the amount of your own annual contribution.

Employers usually choose between two approaches: 1) match a percentage of employee contributions up to a specified dollar amount of total salary, or 2) directly match employee contributions – dollar for dollar – up to a specified dollar amount of total salary. The most common match, according to Vanguard’s 2018 How America Saves report, is 50% of every dollar an employee contributes, up to 6% of salary.

It’s important you understand how this is computed because you may wish to contribute only a portion of your salary up to the point where the employer contribution stops, and then use any additional funds you may have to invest somewhere else where you have more options to choose from.

Investment options

What are your investment options under these plans? They are likely to be mutual funds, and these options vary greatly from one plan to another in both numbers of choices and in quality of those choices. If you don’t know how to evaluate the investment options available to you, consider consulting a competent professional How to Choose and Work With a Financial Adviser to analyze them for you and to make objective recommendations.

The average 401(k) plan includes 8-12 investment options, most commonly mutual funds.

Plan fees

What are the plan fees – administrator fees, investment fees, commissions, loads and sales charges, 12b-1 fees, etc.? You can find some of this information in your 401(k) plan’s summary description, and you want to know what they are before you sign up. You can also ask for a prospectus for any funds you are considering or all of the funds the plan offers.

You also want to know how these fees are paid – are they deducted from investment returns, paid by the employer, or deducted from the plan’s assets? According to 401(k) analytics firm BrightScope, fees range from a low of 0.20% to 5.0%.

Your future work plans

What if you expect to work for only a short time, or have no idea how long you might work, with your new employer, should you still consider a 401(k) plan provided the vesting period starts immediately?

Short answer: yes, because when you leave you have the option of rolling over your contributions from a 401(k) to an IRA by doing a trustee-to-trustee transfer that does not result in any taxes being due. You don’t “lose” your money or have it taxed if you meet the IRS guidelines when moving funds.

Before you decide to do a rollover, compare the investment options and fees from your existing plan with your new employer’s plan; it may or may not make sense to do a rollover.

Borrowing options

Can you borrow (borrow, not withdraw) some of your own money from your 401(k)? Yes, if your plan allows it, but don’t do it because the loss in future retirement income is likely to be substantial, and you may never repay it even with the best of intentions which will result in significant taxes and penalties being assessed by the IRS.

If you decide to borrow anyway, ask yourself if you are using the loan to live beyond your means, and make sure you have a realistic plan to avoid default.

Plan flexibility

Can you move a portion of your 401(k) balance to an IRA while you’re still working for your employer? Yes, provided your employer supports in-service distributions. If your employer offers funds that do not meet your investment objectives you might want to consider an in-service distribution. Before you do however, make sure you discuss it with a tax advisor or financial planner as the rules can be tricky.

If your employer allows in-plan conversions, you may be able to convert assets in your 401(k) to a Roth 401(k). See How to Choose Between Traditional 401(k)s and Roth 401(k)s. Once again, consult a tax advisor before proceeding.

Is participation in a 401(k) plan enough to assure you a comfortable retirement?

If you do participate in a 401(k) plan, should you rely on that plus hoped-for future Social Security benefits as your only financial assets to assure a comfortable retirement? Maybe, if you have well above average earnings over a long period of time contributing to the 401(k), and you were born before 1960. Beginning in 1960 the age for Social Security full benefits begins rising from 65 to 67.

If you do not expect to meet both of these criteria, contributing to 401(k)s is still a good idea, but it is not the whole answer to achieving a comfortable retirement.

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Maybe, but probably not. Don’t be swayed by people who tell you it’s a great idea since you’re simply borrowing your own money and paying yourself interest.

Some factors to consider:

Is borrowing this money earmarked for a good cause?

There’s a big difference between using it for a down payment on a house and taking an expensive vacation. And if you’re thinking you can use it for loan consolidation, how sure are you based on past behaviors that you won’t run up another pile of debts having consolidated and paid off the first pile?

Have you compared all your options for raising money?

Is a personal loan an option? Is waiting until you have saved the amount an option? Is borrowing from family members an option?

Have you weighed the advantages and disadvantages of 401(k) loans?

Advantages include quick approval, the likelihood of a lower interest rate than your other options, a payback period of five years or fewer, and total flexibility as to what you use the funds for.

Disadvantages can be ugly. Leaving your job for any reason requires paying the loan back by the date your next tax return is due; failure to do so means the IRS will treat the loan as a withdrawal, tax you on that amount, and slap a penalty on top of that if you are less than 59 ½ years of age. Ouch.

Perhaps the greatest disadvantage is the loss of the compounding effect for building your savings because the money you withdraw is no longer working for you over extended periods of time.

So, good idea or not?

If you take the loan you are betting that your job situation will not change, that you will have no trouble paying the loan back, and that the loss over time due to missing out on the compounding effect will not be an issue in your future. For many, these should count as show stoppers.

Think carefully, and choose wisely.

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The overly simplistic answer:

If you believe your income tax rate is higher in your working years than it will be in your retirement years, choose the 401(k); otherwise choose the Roth 401(k). The catch – how are you supposed to know?

A better answer

If you can, do both. In retirement, this will give you the flexibility to make withdrawals that are the most tax efficient given your financial circumstances at that later time.

And some good advice

IRS rules can be both complicated and confusing, and they canfrequently change. You are ecouraged to seek advice from a financial advisor or retirement tax expert to make sure your assumptions are valid before making major decisions.

Cash flow implications

With a traditional 401(k) plan, you get an immediate tax benefit as the before-tax contributions are not subject to tax until later when they are withdrawn. With a Roth 401(k) you don’t get an immediate tax benefit as the funds are contributed with after-tax money, but you do get a later tax benefit as there is no tax assessed when the funds are withdrawn when they are considered to be qualified withdrawals.

Note this means that your take-home pay will be somewhat higher with a traditional 401(k) compared to a Roth 401(k) as you will not pay taxes now on a portion of it. Also note that if you do not expect to pay any federal taxes because of the 2026 individual standard deduction of $16,100, then a traditional 401(k) which allows you to defer taxes when you won’t owe any isn’t helping you.

Because contributing to a traditional 401(k) reduces your taxable income in the year in which the contribution is made, the lowered income may improve your eligibility for tax credits and allowable deductions. It’s therefore important to estimate your income and taxes before choosing one plan over the other.

Contribution limits and required distributions are different

While there are contribution limits in 2026 ($24,500 0r $32,500 if you’re at least age 50) for both traditional 401(k)s and Roth 401(k)s, there are no income limits for eligibility to contribute to Roth 401(k)s. These contribution limits apply to the aggregated total of your Roth 401(k) plus any pre-tax deferrals such as a 401(k). Note Roth 401(k) contribution limits are not aggregated with IRA or Roth IRA contribution dollar limits.

With traditional 401(k)s, RMDs (Required Minimum Distributions) need to be taken beginning at age 73. For Roth 401(k)s, RMDs are not required.

Note that Roth 401(k)s can be rolled over to Roth IRAs without incurring any tax liabilities since the dollars that went into the Roth 401(k) were after tax dollars.

Employer matches and rollovers are different

Employer matches work differently with the Roth 401(k). Employer contributions to a traditional 401(k) go directly into your traditional 401(k). Employer matches to a Roth 401(k) go into a pre-tax account that is tracked separately from your employee contributions. From the IRS viewpoint this makes sense because the employer’s contribution has not yet been taxed, but this fact complicates the issue of deciding which plan to choose.

Rollovers are taxed differently with the two plans. Rollovers from a traditional IRA to a Roth IRA are taxed at the taxpayer’s marginal tax rate. Rollovers from a Roth 401(k) to a Roth IRA are not taxed.

Why might you want to do a rollover from a Roth 401(k) to a Roth IRA? One reason might be the custodian of the Roth IRA may have significantly better investment options and lower fees than your options with your employer’s Roth 401(k) plan.

Summarizing the important factors

Making smart choices now can save you thousands of tax dollars later. Here is a summary of factors that should be taken into account when deciding between traditional 401(k) plans and Roth 401(k) plans:

• Whether your employer contributes to your retirement plan and, if so, at what rate.
• Current and assumed future tax rates.
• The taxable income effect on your choice as it relates to income-based eligibility cutoffs and other phaseouts for federal tax liabilities. Examples of these are the Saver’s Credit, the Earned Income Tax Credit (EITC), and the Premium Tax Credit (aka the Obamacare subsidy).
  
• Future assumed social security benefits.
• Your current salary and your salary growth potential.
• Whether you have a defined benefit plan.
• Whether you are able to put aside current and future funds for savings and retirement.
• Investment options and fees for your traditional 401(k) versus a Roth 401(k).

And to repeat earlier advice – IRAs can be complicated, and it’s easy to be confused. Don’t be reluctant to find a financial professional who keeps up with the latest IRS changes in order to give you the best possible advice.

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An HSA is a tax-sheltered account for individuals to save for medical expenses that aren’t covered by high deductible insurance plans. You can use an HSA account to meet your current health plan deductible and other out of pocket expenses. And you can contribute to an HSA regardless of your income.

What are the requirements for opening an HSA in 2026?

For 2026, the key requirements for Health Savings Accounts (HSAs) include a minimum high-deductible health plan (HDHP) with a deductible of at least $1,700 for self-only or $3,400 for family coverage, and an out-of-pocket maximum of no more than $8,500 for self-only or $17,000 for family plans. The maximum annual contribution limits are $4,400 for self-only coverage and $8,750 for family coverage, with an additional $1,000 “catch-up” contribution allowed for those aged 55 and over.

Benefits

HSAs have one very attractive and unique benefit – they are triple tax sheltered. They are funded with pre-tax dollars that are deducted from your gross income or excluded from income if contributed by your employer.

All contributions grow on a tax-free basis, and withdrawals are tax-free if the money goes for qualified medical expenditures (detailed below).

Healthcare cost projections later in life

An August 2018 survey done on behalf of the nonprofit Employee Benefit Research Institute found that:

In 2019, a 65-year-old man with $79,000 in savings and a 65-year-old woman with $104,000 in savings have a 50 percent chance of having enough to cover Medicare and supplemental-plan premiums and median prescription drug expenses in retirement.

At age 65, a couple with median prescription drug expenses needs $183,000 in savings for a 50% chance of having enough to cover healthcare expenses in retirement. Note these odds are equivalent to flipping a coin.

If that doesn’t concern you, it should, unless you believe you will have that covered by other retirement assets. Also keep in mind that increases in medical expenses have exceeded the general inflation rate in the past.

How HSAs work

Pre-tax annual contributions in 2025 can be made for individuals up to $4,300, contributions of $8,550 can be made by people with family insurance coverage, and an additional catch-up contribution can be made of $1,000 for individuals 55 years of age and older.

HSAs can be rolled over to spouses without taxation.

You can withdraw money any time without penalty for qualified medical expenses for you, your spouse, and any dependents. These are qualified medical expenses: co-payments, co-insurance, health insurance deductibles, dental and vision care, prescription drugs, Medicare Part B and Part D prescription-drug premiums, wheelchairs and walkers, hearing aids, X-rays, ambulance services, long-term care services, nursing home expenses, and nursing services at home.

If you withdraw money for non-medical reasons there is a 20% penalty in addition to the withdrawal being taxed as ordinary income, but once you are age 65 or older, distributions for non-medical expenses such as paying Medicare medical insurance premiums, employer-provided health insurance, COBRA, or long term care insurance are not subject to the 20% penalty.

There is no time limit on when the funds can be used. And there is no “use it or lose it” provision; once the funds are contributed they remain in your account until they are withdrawn. They do not have Required Minimum Distribution requirements.

What to look for in HSAs

If you begin looking into options for HSAs, pay special attention to maintenance fees and investment options; they can vary widely and are critical in the choice of plans as they can significantly affect account balances over time. Banks, credit unions, and some large investment firms offer HSAs; if you want to treat your HSA as a sort of triple tax advantaged IRA that’s reserved for health care expenses, then you should probably start your research with the large investment firms.

If you have an HSA with your current employer and expect to change employers, ask if your HSA balance can be transferred. If so, make sure it is a trustee to trustee transfer to avoid any tax issues.

Be aware that the rules change from year to year. If you open one, you should track changes from year to year. The Internal Revenue Service (IRS) provides official guidance each year, e.g. the publication Publication 969 (“Health Savings Accounts and Other Tax‑Favored Health Plans”).

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