I think our fearless leaders in congress don’t always get it right. If fact, I’d go so far as to say they generally make a royal mess of things.
But when they created the 401k plan in 1978, they created the single best tax shelter and asset protection tool in U.S. history. And importantly, they made it available to ordinary Americans and not only the super-rich.
It’s no exaggeration to say that the humble 401k offers better tax savings and lawsuit protection than even the most complex (and expensive) offshore trust scheme.
In 2018, you can defer a maximum of $18,500 of your income ($24,500 if you are 50 or older) and stuff it into your 401k account, not including any employer matching. Depending on how generous your employer is, matching and profit sharing can add thousands of additional dollars to your account every year.
Let’s play with the numbers. If you and your spouse are in the 24% tax bracket (combined annual income of $165,000 to $315,000), contributing the full $18,500 apiece amounts to $8,880 in tax savings.
You should make every reasonable effort to max out your 401k every year.
But if money is tight and you’re having a hard time making ends meet on a reduced paycheck, I have a little trick for you.
The thing you should always remember is that your cash is fungible. A dollar in your left pocket is no different than a dollar in your right pocket. With this in mind, you can “convert” taxable savings sitting in your bank account to tax-deferred savings in your 401k.
You can’t literally move money from your checking account to max out your 401k, of course, as the funds have to come out of your paycheck.
If you have cash savings sitting in the bank, you can live off of it for a few months while you dump your entire paycheck into the 401k plan.
Once your contribution is maxed out for the year, you go back to living off of your paycheck. The net result is that you will have moved your cash savings from a taxable account to a tax-free account.
Unlike IRA contributions, which can be made up until the tax filing deadline in the following year, 401k contributions have to be made during the current calendar year.
So, if you want to save money on your 2018 taxes, you need to make the contributions before December 31.
If you have taxable cash on hand that you want to “convert” to tax-free 401k money, you still have time to do it this year.