If you are working, you most likely have a 401(k) plan for your retirement.
A 401(k) plan has taken over the pension plan and is the only opportunity you have to save for retirement from your paycheck directly. All other retirement planning must be done on your own through an IRA or Roth IRA.
Let’s take a look at how this works.
What is a 401(k)?
A 401(k) is a retirement plan provided to you directly through your employer. The name comes from the section of the US IRA that outlines it.
When you start a new job, you will be given an option to sign up for your employer’s 401(k). A certain percentage of your paycheck will go directly into this account.
If you choose to invest your money in this account, your employer may also match some or all of your contributions. Always make sure you are getting the maximum contribution from your employer.
How do you choose an investment in a 401(k)?
When you open up a 401(k), you will be given investment options.
Depending on what your employer sets up, you can choose from stocks, bonds, or mutual funds. Make sure you look at this list and do your research for what is the best option for you. A good rule is to find a fund that follows the S&P 500 if you are unsure of all of the options.
Can I have a Roth 401(k)?
Most employers give you an option to put your money in taxed or not taxed, also known as a Roth option or traditional option.
A traditional option will be pre-taxed, and you will not pay taxes now, but you will when you withdraw. A Roth option will be after-tax income, and you will pay taxes now, but you will not when you withdraw.
Some employers allow you to choose if you want a traditional or Roth 401(k). You may even have the option to split your contribution into both accounts. You can have the benefits of both accounts if that works for you. The contribution limit applies to the total that you put into this account, not a traditional and Roth portion.
Are there contribution limits to a 401(k)?
Just like other retirement accounts, there is a contribution limit for your 401(k). As of 2022, an individual can contribute up to $20,500 a year. Last year it was $19,500. If you are someone who wants to max out their plan, make sure you know of the contribution increase so you can always max out the new limit.
What is Employer Matching?
Some companies offer an employer match to the amount you invest in this plan.
It is different for every company, so ask your HR team about your matching policy.
- Some companies match 50 cents for every dollar you contribute up to a certain amount.
- Some match a percent of your salary automatically for having a 401(k) with your workplace.
Always make sure you understand the employer match to get this “free” money.
When can I withdraw from my 401(k)?
Once you are 59 1/2, you can withdraw from your 401(k).
If you have a traditional 401(k), you will have to pay taxes on what you are withdrawing because you have not yet paid taxes on this money. If you have a Roth 401(k), you will not have to pay taxes on what you are withdrawing since you already paid taxes on this money.
For early withdrawal, there is usually a fee of 10% on top of paying taxes on that money. Using your plan as a savings account is not ideal. This really should be used for retirement.
Your employer may allow you to take out a loan again their matching on your 401(k). However, you will have to pay this loan back, and if you leave before paying back this amount, there could be additional fines.
Final Thoughts on 401(k)
Take advantage of this if your employer offers a 401(k) and match.
For most people, this is their only account for retirement. If you can’t max out the contribution limit, at least put in the minimum for you to get your employer matching.
For long-term planning, consider opening up a 401(k) and other retirement accounts to account for your living expenses when you retire.
