The governing body for 401(k) plans was established by the Revenue Act of 1978 and the Employee Retirement Income Security Act (ERISA) of 1974. These plans, along with their corollary 403(b) non-profit and 457 government employee plans*, have become the major method for funding employee retirement plans. As of December 31, 2024, these plans hold a total of $8.9 trillion. The Roth IRA was made possible by the Taxpayer Relief Act of 1997, and its provisions made it possible to increase tax-advantaged retirement savings. With the introduction of Roth 401(k) plans in 2006, the Roth legislation received an additional wrinkle. Despite the fact that they both accept after-tax contributions, these two Roths differ significantly. Roth 401(k) accounts are not available to individuals, but Roth IRA accounts are. Your employer must offer a Roth 401(k) as part of the retirement plan package. Contributions rules also differ markedly (see below).
Health Savings Accounts (HSA) and 529 Education Accounts complete the quartet of instruments available to taxpayers.
A good basic understanding of the rules governing the plans and their relationship to the federal tax code is essential to create and manage your wealth accumulation. First, let’s look at how these various plans fit into the federal tax code. *While the rules for 401(k), 403(b), and 457 plans are not exactly the same, their contributions and interactions with the federal tax code are largely the same. Therefore, when I refer to 401(k) plans in this blog please assume that I am including 403(b) and 457 unless designated otherwise.
As you can see, 401(k) contributions are deductible from your gross income for the year the contribution is made, accumulate within the plan tax free but are taxed upon withdrawal. On the other hand, Roth IRAs and Roth 401(k) plans are funded with money earned after taxes, can grow tax-free, and can be withdrawn without being taxed. HSA plans are one of a kind under the federal tax code because they are tax-deductible in the year of contribution, accumulate tax-free, and are tax-free when withdrawn for eligible medical expenses. They are shielded from the triple tax! Contributions to a 529 account interact with federal income taxes in the same way that contributions to a Roth IRA do: after-tax, tax-free accumulation and tax-free withdrawal. However, each state has its own set of management guidelines for these accounts. (A good overview is provided here.)
Contributions
For employees, the 401(k) contribution limit for 2025 is $23,500. Employers can contribute additionally up to a total combined contribution of $70,000. Certain older age groups are eligible for additional catch-up contributions. Some plans include a Roth 401(k) option. This can allow you to contribute after tax dollars in addition to the pre-tax dollars to your 401(k). Nevertheless, your combined contributions cannot exceed $70,000. The decision regarding how to divide your contribution between pre-tax and post-tax funds necessitates some crystal ball gazing if you have such an option. If you foresee being in a higher tax bracket after you retire then paying your taxes on your contributions now rather than after retirement might make sense.
Roth IRA accounts can be opened by individuals as an additional means of increasing their retirement savings. The contributions are made with after-tax dollars and the annual limit is $7000. However, Roth IRA contributions include a phase out provision. For single taxpayers covered by a workplace retirement plan the phase out begins at a taxable income of $79,000 and ends at $89,000. That means that below $79,000 you can make the full contribution which decreases until you reach $89,000. Contributions to Roth IRAs in excess of $89,000 are prohibited. For married couples filing jointly, if the spouse making the contribution is covered by a workplace plan the phase out begins at $126,000 and ends at $146,000. If the contributor is not covered at work and the spouse is covered the limits change to between $236,000 to $246,000.
Health Savings Accounts (HSAs) were established in 2003. They allow annual contributions made with pre-tax money.
The contributions grow tax free inside the HSA and can be withdrawn for qualified medical expenses tax free. To make contributions to an HSA you must be enrolled in a health plan that is HSA eligible and has a deductible amount of at least $1650 for single individuals and at least $3300 for families. Contribution limits for 2025 are $4300 for single individuals and $8550 for families. If you are over the age of 55, you can make a catch-up contribution of $1,000 per year. The disadvantage of HSAs is the high deductible requirement. Therefore, an HSA might not be a good idea if you anticipate having a medical need in the coming year, such as having a child. Contributions cannot be made once you’re Medicare eligible and cannot be used to pay your health plan premiums. Withdrawals for non-qualified expenses are subject to tax as ordinary income and, if under age 65, an additional 20% penalty. However, once you reach Medicare age you can use HSA funds to pay your Medicare premiums.
