Does your employer offer a 401(k) plan? Find out the answers to these common 401(k) questions to help set yourself up for a successful retirement.
Many employers offer a 401(k) or similar retirement plan, yet many employees don’t take full advantage of them. There could be many reasons for this, including a lack of understanding of how 401(k) contributions impact financial planning for your retirement or high expenses currently.
With inflation and increasing life expectancy, you may need to stretch your investments over a longer period of time than you expect. This is more reason to start saving early and take advantage of the benefits of a 401(k) plan. The last thing you want to do is run out of money after you retire. To avoid finding yourself in such a situation, learn about the benefits of contributing to a 401(k) plan during your working years.
A 401(k) plan is an employer-sponsored retirement savings account. It is set up by the employer and gives employees the option to contribute a certain dollar amount or percentage of their salary. Most 401(k) plans give employees the option of investing their money in various assets such as stocks or mutual funds. Putting away a percentage of your paycheck and investing that amount to help save for retirement is one of the main advantages of contributing to a 401(k) plan. Some employers match employee contributions up to a certain percentage—Free money!—and if you contribute at least up to that company match, your investment returns could get an extra boost.
Another advantage is the potential tax benefit. If you are making pre-tax contributions, your contributions will be deducted from your paycheck and could lower your current income taxes. The contributed amount grows on a tax-deferred basis and you will be taxed when the money is withdrawn.
In this article, we will answer some common 401(k) questions to help clear up some other questions we often hear.
Q: How much of my salary should I contribute?
It is generally good to save as much as possible for retirement, but you should do so within your means. While there is a maximum amount you can contribute, don’t contribute so much you aren’t able to pay your bills. The Internal Revenue Service (IRS) sets limits on how much you can contribute to a retirement plan. This maximum contribution amount often increases to keep pace with inflation, so it is a good idea to check this annually. If reasonably possible, you should try to max your 401(k) contributions each year.
There are restrictions for when you can access the money you have put away in your 401(k). For this reason, it may be wise to save some of your money in other investment accounts just in case you have unexpected costs that arise before retirement.
Q: What is the difference between traditional and Roth contributions?
These are two basic types of retirement plan contributions you may come across. What is right for you depends on your personal situation, and it may be worth asking a tax advisor.
Traditional 401(k). Contributions are pretax—money you haven’t paid income taxes on yet. This can lower your current taxes paid and allow your account to grow. But it could mean more taxes when you withdraw later.
Roth 401(k). Roth contributions are tax exempt—you pay income taxes before you contribute, but once in your retirement account, they grow free of capital gains taxes. This means when you sell securities or withdraw from them after you have held the account for a certain number of years, you will most likely not have to pay taxes.
Q: When can I access the money in my 401(k)?
According to the IRS website, you could start taking withdrawals from a traditional 401(k) when you reach retirement age.[i] You could also take hardship withdrawals if you have an immediate need for finances. There are some other instances such as if your employer terminates the plan or if you pass away. Withdrawals from Roth 401(k)s may be more flexible. Refer to the IRS for specific rules.
You may be able to take a loan from your 401(k) if the need arises. However, note some caveats: If you can pay off the loan quickly then it may be OK. But if that loan is going to take long to pay off, you may end up paying taxes or penalties.
Q: What if I have multiple 401(k)s?
You have a couple of options. You could either try to rollover the funds into an Individual Retirement Account (IRA) or your current employer’s plan. You may be able to leave the account open at the previous custodian. However, to track down where that money is held you may have to call the financial institution directly in some cases.
Q: How can I find out about my firm’s retirement plan or 401(k)?
If your employer offers a retirement plan or benefits, the Human Resource Department should be able to provide more information. You can get more details by contacting your plan’s provider, which is usually an external administrative vendor.
Q: How can I convince my employer to get a retirement plan or 401(k)?
It may be a good idea to first find out why your employer doesn’t offer a 401(k) plan. Before convincing your employer to get a retirement plan or 401(k), speak to your coworkers and find out what they would want in a retirement plan. With their collective support you could present a case to your employer.
If you have a retirement plan or retirement accounts and are unsure how to invest or plan for retirement, we may be able to help. Contact us today to speak with one of our qualified representatives or download one of our educational investing guides to learn more.
[i] Source: Internal Revenue Service, as of 07/09/2019. 401(k) Resource Guide - Plan Participants - General Distribution Rules. https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-general-distribution-rules.