When it comes to retirement savings, people often invest in 401(k)s and IRAs with the expectation that their money will grow. However, some people end up losing money on their investments in a 401(k) plan.
This is called a 401k loss tax deduction and it can be an important tool for retirees who are struggling with their finances. But claiming this deduction isn’t easy.
Loss deductions are itemized deductions
If you lost money on a 401k investment, you may be able to claim a 401k loss tax deduction. However, there are some important rules to remember. First, you must have basis in the 401k plan. That means that your nondeductible contributions must have been paid before you incurred any taxable income for the year.
Second, your losses must be less than your total distributions from the 401k plan over the life of the account. That means that if you cash out your 401k in a year when you have a large amount of nondeductible contributions, your losses won’t count.
Despite these limitations, the 401k loss tax deduction can be beneficial for many people. But it’s not a tax break you should take every year. Instead, it’s best to wait until your marginal tax rate is lower in the future. Alternatively, you can contribute more to your 401k or IRA over multiple years to reduce your taxable income and maximize the itemized deductions that you’ll receive.
They are subject to the 2 percent of adjusted gross income limit
While a loss is not a tax break on its own, they do make for big savings in the long run. The best part is that you don’t even have to be a 401k participant to take advantage of this tax break. There are a number of tax deferral options, including company matching and employee contributions, plus a few tax-free perks, like the Saver’s Credit for eligible employees. In fact, it is a good idea to consult with an accountant or tax professional before making your own retirement contribution decisions. Taking the time to learn your options will help you maximize your bottom line and avoid unpleasant surprises.
They are limited to the year you close the account
One of the best ways to save tax dollars is to tuck your hard earned cash away in a tax deferred savings plan like a 401k. While it may be difficult to come up with a witty 401k retirement plan design, there are some tricks of the trade that can help you get the most out of your tax savings dollar. The most important rule of thumb is that the 401k should be an investment you make in a single lump sum rather than spreading it out over several payments. If you do decide to dip your toe in the water, it pays to do your research and shop around.
They are taxable
The 401k loss tax deduction is a great way to offset taxes in the year of the loss. However, the tax deduction is limited by your adjusted gross income.
The IRS classifies a 401k loss as a miscellaneous deduction, subject to a 2 percent of adjusted gross income limit. So if your loss is only $7,000, the tax break is limited to $6,000.
When you claim a loss, it’s important to consider the basis of the investment. This means the amount of nondeductible contributions you’ve made to the 401k and other retirement plans minus any distributions that have been taken out, including a distribution to close your accounts.
The IRS offers a tax credit called the Saver’s Credit that lowers your taxable income by a percentage of your 401k contribution. It’s available to individuals and married couples filing jointly, and it applies to the first $2,000 you put into your 401k each year.