Here’s everything you need to know about taxes, 401(k) plans, and IRAs

Taxes, 401(k) plans, and individual retirement accounts or IRAs are complicated. But it’s important that you understand the basics of both your personal taxes and your retirement options in order to make informed decisions about your future.

Americans don’t spend enough time doing their taxes — an average of just 12 hours along with $230 to file the paperwork, according to the IRS — to get the most bang for their buck.

“Your tax return isn’t that easy by any means,” said Mark Steber, chief tax information officer at Jackson Hewitt Tax Service. “I don’t care who you are or what economic situation you’re in — high, middle, low, no income or unemployed.”

In fact, tax experts like Steber say all of these IRS tax return forms and schedules are actually designed to help people save money.

“If you know how it works, you can use tax law to your long-term advantage,” said Sheneya Wilson, founder of Fola Financial in New York. “However, most people don’t have that knowledge, and I think that’s what triggers this fear of the IRS and paying taxes when the tax laws aren’t essentially there to harm anyone.”

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Retirement plans are also an important part of your annual taxes. Until the 1980s, most Americans planned their retirement through annuities or defined-benefit plans, in which employers calculated employees’ retirement benefits based on their years of service and their most recent salary. That changed when Congress passed a new tax law in the Revenue Act of 1978. The law included a new provision in the Internal Revenue Code, Section 401(k) that gave employees a tax-advantaged opportunity to defer compensation from bonuses or stock options.

401(k) and other defined contribution plans have supplanted traditional retirement plans over time. Under 401(k), employers create a retirement plan into which employees can contribute a portion of their wages on a pre-tax basis, up to an amount set by the IRS.

From 1980 to 2008, participation in pension plans fell from 38% to 20% of the nation’s workers, while the number of workers covered by defined contribution plans rose from 8% to 31%, according to the US Bureau of Labor Statistics.

As of 2020, there were approximately 600,000 401(k) plans, with approximately 60 million Americans participating; it is one of the most popular retirement options for US workers.

When people think of retirement planning, IRAs probably come to mind alongside 401(k) plans. The main difference is that employers offer 401(k) plans while individuals open IRAs. There are pros and cons to both, but by understanding how to contribute and invest those contributions, you can maximize your returns before retirement in both a 401(k) and an IRA.

Watch the video above to learn the basics you need to master to improve your financial picture related to your personal taxes, IRAs, and 401(k) plans.


00:00 – Why taxes in the US are so confusing (April 2021)

12:17 – How 401(k) plans work and why they killed pensions (March 2021)

24:34 – How IRAs work and why they are more popular than 401(k)s (August 2021)

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