401(k) Basics

As a retirement plan, 401(k) plans currently outpace the competition, with more than 54 million Americans participating in a 401(k) plan, and nearly 550,000 plans offered.

Employer sponsored, 401(k) plans are by far the easiest mechanism for workers to get started saving for retirement. And because there is typically an employer match for contributions up to a certain percentage, workers can end up leaving a significant amount of money on the table if they choose to forego participating in the company 401(k) plan.

While most employers will provide employees with information on annual contribution levels and the employer match, there are many things that you should be aware of if you’re planning on contributing to your employer’s retirement plan.  Here are just a few:

1. In 2018, you can elect to defer up to $18,500 from your paycheck directly into a 401(k) account.  If you’re over 50, you’re eligible to contribute an additional $6,000 per year, bringing your yearly maximum to $24,500 in a calendar year.

2. You get an upfront tax break when contributing to a 401(k), as all contributions made are on a pre-tax basis, meaning that the contribution is deferred directly to your 401(k) account prior to taxes being assessed, reducing your income, and ultimately your tax liability for the year.  

3. Contribution levels are adjusted annually, so what you can contribute in the current year could easily change next year, so be sure to keep tabs on the limits, particularly if you’re already contributing the maximum allowed each year.

4. There is no upper age limit to making contributions. One of the major benefits of a 401(k) is that you can continue to make contributions annually as long as you remain employed.

5. Learn what the company match is and take advantage of it, if financially possible.  If your employer currently matches your contributions up to 5%, it would benefit you to defer at least 5% of your salary.

6. Understand that your investment options are going to be somewhat limited. In most cases, the firm that currently manages your company’s 401(k) plan will offer a limited number of fund options, usually around twenty, so you won’t have the freedom to invest in the company or companies that you wish.

7. If you are considering withdrawing from your 401(k), requesting a loan from the plan may be a better option. Most plans offer low-interest loans, with the principal and interest that you pay back going directly into your account.  

8. Learn when you can begin to make penalty free withdrawals, and under what circumstances you can make withdrawals.  For instance, you can begin to make regular withdrawals starting at age 59 ½ without facing a penalty, but understand that since a 401(k) is a tax-deferred plan, you will be responsible for paying taxes on the amounts withdrawn. Under certain circumstances, you can make penalty-free withdrawals prior to age 59 ½, such as if you become permanently disabled, or to pay unreimbursed medical expenses.

If your current employer offers a 401(k) plan, there is no good reason to not participate.  

Resources

https://www.fool.com/retirement/2016/08/28/14-things-you-really-should-know-about-401k-retire.aspx

https://www.thebalance.com/what-is-a-401-k-357114

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