401(k)

A 401(k) Plan is a popular retirement savings plan offered by private-sector employers, allowing employees to contribute a portion of their pre-tax income to tax-advantaged retirement accounts. Many employers match a percentage of employee contributions as an added benefit. Named after Section 401(k) of the International Revenue Code, this plan is designed to help employees save for retirement while providing tax benefits.

Employees can choose from various investment options, such as mutual funds, stocks, and bonds, with earnings growing tax-deferred until withdrawal. Some 401(k) plans also offer a Roth option, allowing after-tax contributions with tax-free withdrawals in retirement.

Key Facts

• Eligibility:
  • It is typically offered to full-time employees.
  • Employers may impose waiting periods before new hires can enroll.
• Contribution Limits (2024):
  • A $23,000 annual employee contribution limit.
  • Employees aged 50 or older can contribute an additional $7,500 as a catch-up contribution.
• Employer Match:
  • Employers often match employee contributions up toa certain percentage (for example 50% of the first 6% of salary contributed).
  • Matching contributions are often subject to vesting schedules.
• Tax Advantages:
  • Traditional 401(k): Contributions reduce taxable income in the year made. Taxes are paid on withdrawals in retirement.
  • Roth 401(k): Contributions are made after-tax, but withdrawals (including earnings) are tax-free if conditions are met.
• Investment Options:
  • Common options include mutual funds, index funds, stocks, and bonds.
  • The employee chooses how their contributions are allocated.
• Withdrawal Rules:
  • Withdrawals before age 59½ are subject to a 10% penalty and income tax, with some exceptions.
  • Required Minimum Distributions (RMDs) must begin at age 73.
• Rollovers: Employees can roll over funds from a 401(k) to another retirement account (such as an IRA) when changing jobs or retiring to avoid taxes and penalties.

1. How much should I contribute to my 401(k)?

Financial advisors typically recommend contributing at least enough to take full advantage of your employer's match. Ideally, aim to save 15% of your income (including employer contributions). Individuals should consult a financial professional or an online calculator to estimate proper investments.

2. What is the difference between a traditional and Roth 401(k)?

• Traditional 401(k): Contributions are made pre-tax, lowering taxable income, but withdrawals in retirement are taxed.
• Roth 401(k): Contributions are made after-tax, so withdrawals (including earnings) are tax-free in retirement.

3. Can I access my 401(k) funds early?

Yes, but early withdrawals before age 59½ are generally subject to a 10% penalty and income tax. Some expectations apply, such as financial hardship, medial expenses, or first-time home purchase (depending on the plan).

4. What happens to my 401(k) if I change jobs?

You can leave it with your former employer's plan, roll it over into your new employer's 401(k) plan, transfer it to an IRA, or cash it out (which may trigger taxes and penalties).

5. Is it possible to lose money in a 401(k)?

Yes, since 401(k) investments are subject to market risk, account values may fluctuate based on the performance of the selected investments. Diversifying investments can help manage risk.