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Dallas, Texas, United States

Monday, September 30, 2019

Pre-Tax Deductions

You should put as much as possible into your 401(k)/403(b) retirement plan and High-Deductible Health Plan (HDHP) Health Savings Account (HSA).  Of course you should put in at least as much into your 401(k)/403(b) plan to get the full benefit of any employer matching contributions.  You should go even further if possible and put up to the annual allowed limits in these accounts to maximize your pre-tax deductions.

With a 401(k)/403(b) retirement plan, you defer paying taxes on the income now and instead pay it later when you are retired and at a lower marginal tax rate.  With an HSA, you do not pay taxes on the income ever if you withdraw the funds for a medical expense.  At age sixty-five, HSA account owners can also withdraw the funds for non-medical expenses without penalty and simply pay income tax just as though it were another type of retirement account.

Because these are such good deals, there are annual limits on how much you can put into these savings accounts.  For the 401(k)/403(b), the annual limit for individual contributions is currently $19,000 per year for those under fifty-years-old and $25,000 for those fifty and above.  For the HSA, it is currently $3,500 for a single person and $7,000 for a family with an extra $1,000 for those at least fifty-five-years-old.

A young single worker could defer taxation on up to $22,500 of their annual income.  Of course if that worker is only making $25,000 per year, said worker will most probably not have the option of saving ninety percent of their income as they will need most of their money to meet immediate living expenses.  Regardless, everyone should strive to put into their 401(k)/403(b) plan at least enough to maximize employer matching contributions since this is usually a more readily achievable limit based on percentage of salary.

Finally, keep in mind that these saving plans can be invested and that the earnings grow tax deferred.  Your retirement and HSA plans will offer you a wide variety of different investment options.  For reasons I described in a previous blog post, I prefer index funds.

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