You know that saving for retirement is critical and that the most commonly-used place to save for retirement is within your workplace retirement plan. However, there are often many general questions employees have surrounding their 401(k) that go unanswered. Read on for ten basics you should know about your organization’s 401(k) plan.
1. What is it?
Your employer’s retirement plan is a defined contribution plan designed to help you finance your retirement. Federal and sometimes state taxes on your contributions and investment earnings are deferred until you receive a distribution from the plan (typically at retirement).
2. Why do they call it a 401(k)?
The 401(k) plan was born over 40 years ago, under Section 401(k) of the Internal Revenue Code, hence, 401(k).
3. You decide
You decide how much to contribute (within the IRS limits mentioned below) and how to allocate your investments. This gives you the advantages of easy diversification – a well-balanced mix of investment choices, and dollar-cost averaging by making regular investments over time.
4. It’s easy
You contribute your pre-tax (and/or Roth dollars in many plans) by making automatic payroll deductions. It’s a simple method of disciplined saving!
5. Know your limits
In 2020 you can save up to $19,500 of your pre-tax dollars. If you are age 50 or older (or turned 50 in 2020), you can save an additional $6,500. For 2021, the amounts remain the same.
6. “Free” money
Many employers will match some of your contributions. This is FREE money and a great incentive to contribute to the plan.
Should your employer make a matching contribution; vesting refers to the percent of your employer contributions that you have the right to take with you when you leave the company.
Some plans allow you to borrow a percentage of your account value by taking a retirement plan loan. Keep in mind that you have to make regular payments plus interest on the loan., and, typically, if you leave employment without repaying the full outstanding balance of the loan, the loan will default and the distributed amount will be considered taxable income for the year in which the loan was distributed.
9. Early withdrawals
You may be able to take a lump-sum payment before you retire, generally for emergencies (hardships). You’ll pay a 10-percent penalty as well as federal and state income taxes. While this is good for emergency situations, remember that your retirement plan is a retirement savings fund, not a rainy-day fund!
10. Leaving the company
When you leave your job, you can rollover your retirement plan savings to an Individual Retirement Account (IRA) which can later be rolled over to a new employer’s retirement plan. This way, you stay on track for your retirement savings goals, without having to start over each time you change jobs.