Wednesday , 22 May 2024

401(k)s: 10 Things You Need To Know

…No matter how old you are, it’s never too late to contribute more to your account and bolster your future retirement security. Here are 10 things you need to know about these retirement plans.

This version of the original article by Rachel L. Sheedy, Sandra Block ( has been edited [ ] and abridged (…) to provide you with a faster and easier read. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

1. You Get a Tax Break for Contributing to a 401(k)

With its name derived from the tax code, the 401(k) is an employer-based retirement savings account, known as a defined-contribution plan. You contribute pretax money from your salary, which lowers your taxable income and helps you cut your tax bill now.

  • If you make $4,000 a month, for instance, and save $500 a month in your 401(k), only $3,500 of your monthly earnings will be subject to tax
  • plus, while inside the account, the money grows free from taxes, which can boost your savings.

2. You May Be Auto Enrolled in a 401(k)

69% of companies enroll employees automatically into their 401(k) plans, allowing workers to opt out if they choose… or choose to set a higher (or lower) rate of savings…

  • Beware, [however, that if you]…rely solely on the default rates you may not end up with a sufficient nest egg, as most experts recommend saving a minimum of 12% and up to 15% of your pay a year
  • and, often, the initial contribution rate for auto enrollment will start at 3% of the worker’s pay escalating…over time by 1% per year, until the employee is contributing a certain amount, typically 10% of their salary annually.

3. There are Contribution Limits for 401(k)s

The IRS sets an annual limit on how much money you can set aside in a 401(k) that is adjusted for inflation annually.

If you cannot afford to contribute the maximum, try to contribute at least enough to take full advantage of an employer match (if your company offers one).

4. Your Company May Match Your 401(k) Contribution

Many employers will help you save in your 401(k) by either:

  • matching an employee’s contribution up to a certain percentage, perhaps 50 cents for every dollar you contribute up to 6% of your pay…
  • or providing contributions to employees’ accounts, regardless of whether employees contribute their own money
  • and some employers may provide the match in company stock.

Whichever way the company helps you save, ask whether there is a vesting schedule for that employer-provided money. You may have to work for the company for a certain amount of time before that money becomes 100% yours.

5. There Are Fees You Pay for Your 401(k)

Unfortunately, many savers don’t realize that 401(k) plans come with fees ranging from 0.5% to 2% of the plan assets…

  • Typically, larger plans will have lower fees but the number of enrollees
  • and the plan’s provider can also affect the cost…
[so] ask your benefits manager for details on your plan’s costs…

6. You Can Choose From a Selection of Funds in Your 401(k)

In a 401(k), your employer will select the investment choices available to employees [such as] actively managed domestic and international stock funds, domestic bond funds, money-market funds and low-cost index funds. You, as the employee, can then decide how to allocate your contribution among those available options.

  • If you don’t make a selection for your contribution, your money will go to a default choice, likely a money-market fund or a target-date fund …[which] typically shifts from a stock-heavy portfolio to a more conservative, bond-heavy portfolio by its target date.

7. You May Have a Roth 401(k) Option

…Not all plans offer the Roth 401(k) option, but if yours does (70% did so in 2018), you are allowed to put in after-tax money in exchange for tax-free growth and tax-free withdrawals in the future.

  • You can choose to divide your annual contribution between the traditional 401(k) and the Roth 401(k). Any employer match will go into a traditional 401(k).
  • Any set up of a Roth 401(k), however, requires that you pay tax based on the investments’ value at the time of the in-plan conversion but beware: unlike IRA Roth conversions, you can’t undo a 401(k) Roth conversion — the decision is irrevocable.

8. You Can Withdraw Money Early from a 401(k)

Money you stash in a 401(k) isn’t meant to be touched until retirement, and any money withdrawn before you turn 59 1/2 could be subject to a 10% early-withdrawal penalty but,

  • if you leave a job as early as age 55, you can tap the 401(k) penalty-free…
  • [and you are] generally allowed to borrow from your account although
    • you may have to pay a fee to take a loan
    • plus, you’ll be charged interest on the amount you take out but you’ll basically be paying interest to yourself because the money goes into the account.
    • If you have outstanding loans when you leave a company the loans will have to be repaid within 60 to 90 days. If not, the amount of the loan will be considered a taxable distribution.

9. You Can Roll Over a 401(k) Account

Workers generally have four options for their 401(k) when they leave a company:

  1. You can take a lump-sum distribution;
  2. you can leave the money in the 401(k);
  3. you can roll the money into an IRA;
  4. or, if you are going to a new employer, you may be able to roll the money to the new employer’s 401(k). (Note: Those with balances of less than $5,000 may not get the option to keep their money in their old plan.)

Whether you roll the money into an IRA or a new 401(k), be sure to ask for a direct transfer from one account to the other because, if the company cuts you a check, it will have to withhold 20% for taxes and, whatever money isn’t back in a retirement account within 60 days, will become taxable. If you don’t want that 20% to be considered a taxable distribution, you’ll have to use other assets to make up the difference. (Once you file your tax return for the year, you’ll get that withholding back.)

10. Eventually You Must Withdraw Money from a 401(k)

…As with IRAs, 401(k)s have required minimum distributions.

  • You must take your first RMD by April 1 in the year after you turn 72.
  • You will have to calculate an RMD for each old 401(k) you own.
  • Once you’ve determined the RMD, the money must then be withdrawn separately from each 401(k).

Note that unlike Roth IRAs, Roth 401(k)s do have mandatory distributions starting at age 72.

  • If you hit that magic age, you are still working, and you don’t own 5% or more of the company, you don’t have to take an RMD from your current employer’s 401(k).
  • If you want to hold off on RMDs from old 401(k)s and IRAs, you could consider rolling all those assets into your current employer’s 401(k) plan.

What you don’t know about converting money from your traditional IRA to a Roth IRA could cost you – or your beneficiaries – dearly – so go here to get Your Guide To Roth Conversions.

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