A person works to cope up with present expenses. He or she also does work to save up for the future. Securing one’s future includes securing your retirement. In the US, most employees avail of a 401K. It is a sort of retirement savings plan that you can deduct automatically from your salary. The actual money in the plan goes to an investment which you can claim and use upon retirement.
In this plan, taxes from the money you have saved up can be deferred until withdrawal of such savings. A certain part of your salary is automatically placed on the 401K account. The amount deducted from your salary and which goes to the 401K account is referred to as a contribution. The agreement in determining what part of your salary is your contribution is set by the employers and the employee. However, policies differ from company to company. There are some that have established rules on this matter. Recently, a new variation of this plan was crafted. It is the Roth 401K plan. With this new scheme, the tax is paid or withheld in the year that you make your contribution. So the total amount that you will be getting from the plan is already tax-free.
Aside from the traditional and Roth classification of 401K, there is also the participant-directed and trustee-directed kind of classification. The latter requires the employee himself to choose a plan among a variety of choices. The options presented range from company stocks or shares, bonds, money market investments or a mix of any. In the trustee-directed plan, it is the company or employee who chooses where to invest your money. They could also hire a trustee to decide for you.
Since tax deference applies when you avail of a 401K plan, maybe you are concerned with how this will affect your payroll tax. Your employer comes up with a payroll tax by subtracting several payroll deductions from your salary and then applying the appropriate tax rates. Here are the things you need to do:
- Determine first your income. This amount is obtained by multiplying salary by the number of hours you worked.
- You must know the deductions made on your gross income. This would normally include Social Security tax and the Medicare taxes. These are part of the Federal Insurance Contributions Act. Under this act, Social Security tax accounts for 6.2% deduction while medical care taxes accounts for 1.45% deduction. Health insurance premiums and or life insurance premiums and some other variable tax deductions also exist, depending on your employer.
- Check the taxation rules of your state. Specifically, verify the legality of you being allowed to have a pre-taxed deduction by your state. Look for a tax manual. If it is uses the computation for modified gross income, then you are allowed to have your deductions pretaxed.
- Find out how much deduction will be placed on your state and locality on your tax. Solve this by getting the quotient of the amount deferred from a previous paycheck and the check’s gross amount.
- The next set of taxes you need to determine is the federal tax. You can do the same process of computation as with the state tax. You can find the percentage by dividing the amount deferred from a previous paycheck by the check’s gross amount.
There you go. You now know the amount of tax you will be paying with a 401K plan.