401(k)
Many Americans have the bulk of their retirement savings in Employer sponsored plans like a 401(k). Understanding how and when you can access your money and which option is best for you are vital when using this tool to plan for retirement.
Frequently Asked Questions:
What is a 401(k)?
A 401(k) is a qualified, employer-sponsored, defined contribution retirement plan that allows participants to make contributions, which are deducted from their paycheck each pay period. In years past, defined benefit plans aka “pensions” were the primary source of funding one’s retirement that generally was the employer’s responsibility for funding. In today’s world, however, the burden of saving for retirement has been shifted to the employee. While not required to do so, many employers do, however, offer a matching contribution to encourage employees to save. For example, if your employer will match the first 3% of your contribution, this essentially turns a 3% contribution rate to 6%. Other employers may make profit-sharing contributions to employee plans.
The 2024 limit for pre-tax contributions is $23,000. Those who are age 50 or older are allowed to make additional catch-up contributions of up to $7,500, for a total pre-tax contribution max of $30,500. It’s important to note that contributions can only come from payroll deductions – you cannot cut a check to your 401(k) plan from your checking/savings account like you could do to fund an IRA.
How much can I contribute to my 401(k)?
When can I access my 401(k) funds?
Generally, if you withdrawal funds prior to age 59 ½ from your 401(k), you will pay income tax and an additional 10% penalty tax on the distribution. There are some regulations that allow you make to penalty-free withdrawals prior to age 59 ½ (click here to see what the exceptions are to avoid the 10% penalty). Some 401(k) plans also allow the participant take a 401(k) loan from their own account. If a loan is permitted, in most cases, participants can borrow up to 50% of their vested account balance with a maximum of $50,000, whichever is less. Bottom line – taking money out of a 401(k) plan prior to retirement is very rarely recommended but sometimes necessary given an unforeseen life event.
You have full control over your 401(k) and are completely responsible for the ongoing management of it. The investments available for you to use for your account are chosen by your employer and you are limited to only using those holdings.
Who controls the 401(k) and how is it invested?
What happens when I ultimately leave my employer?
Click here to learn about your options and why it could make sense to consider an IRA rollover when you separate from service. It’s important to note that you’re always entitled to receive the full balance of the dollars within your 401(k) plan that are associated with the money you contributed (minus applicable taxes and any potential penalty associated with an early withdrawal). However, depending on how your 401(k) plan is structured and how long you’ve been with your company, you may or may not be entitled to receive the full balance of the dollars within your 401(k) plan that are associated with matching contributions your company made. Matching contributions are often subject to a “vesting schedule” (determined by your employer) and the full amount would only be available once you’ve satisfied the vesting schedule.
What types of contributions are allowed in 401(k) plans?
Similar to IRAs, the two main contribution types for a 401(k) plan are Traditional or Roth contributions.
The Traditional 401(k) contribution type lowers one’s taxable income for the year, however, all dollars when withdrawn (contributions and earnings) are fully taxable.
With a Roth 401(k), you are limited to the same $23,000 (or $30,500 if 50 and older) annual as a Traditional pre-tax 401(k) and contributions do NOT lower your taxable income for the year. The benefit of the Roth contribution comes later on when funds are withdrawn and no taxes are due on distributions (contributions and potential earnings).
A third and lesser-known contribution type is the “after-tax” 401(k) option. Many folks confuse the “after-tax” and the “Roth” contribution type but it’s important to note that they are two very different things. The after-tax contribution type is best utilized when the Roth or Traditional 401(k) contribution level has already been satisfied and you have the capacity to save more. Depending on your 401(k) plan, there could be an opportunity to roll funds out of the after-tax component of your 401(k) each year to a Roth IRA for future tax-free growth. This is a more nuanced planning consideration that you’ll want to explore with your advisor if you have the capacity to save above and beyond normal 401(k) contribution levels.