When it comes to saving for retirement, it’s never too early to start. However, making an educated choice on how to best optimize your savings can seem like an overwhelming task. We at Atrium know how intimidating a 401(k) plan can seem to a beginner, but don’t worry! We’re here to give you all the inside scoop that will set you up for a long and abundant retirement. Here is our Beginners Guide to 401(k):
What is a 401k?
A 401(k) plan is a retirement and investment plan that employers offer, where a percentage of an employee’s salary is put into account and then invested in stocks or bonds.
Some of the 401(k) benefits are:
- The percentage of funds contributed to a 401(k) has the potential to be matched by employers
- Employees with a 401(k) plan will be eligible for a tax break for their contributed funds, either when they contribute or when they withdraw it in retirement, depending on which plan they have.
Roth 401k vs Traditional 401k
There are two types of 401(k) options that an employee can choose from: a Roth 401(k) and a Traditional 401(k). The main difference between these two 401(k) plans is when the employee is taxed.
In a Traditional 401(k) plan, all deductions are pre-taxed, which means you delay paying taxes on a portion of your income until you retire.
In a Roth 401(k) plan, all contributions are post-tax, which means you pay taxes on your contribution up front, and when you withdraw your money in retirement it will be tax free.
When deciding between a Roth 401k and Traditional 401k plan here are some things to consider:
- Although future tax rates are difficult to predict, you may benefit from a Roth 401(k) if you anticipate being in a higher tax bracket during retirement.
- Even if your taxes remain stable, you may face a higher tax bill in retirement if: you will no longer claim deductions for dependents, mortgage interest, and others frequently utilized by families. If this sounds like a likely scenario, a Roth 401(k) might be to your advantage.
- If you do not require your 401(k) assets for living expenses in retirement, a Roth 401(k) offers the opportunity to roll over to a Roth IRA, which may enhance the potential tax-free growth of your assets and may enable you to give a larger portion of your assets to your heirs.
- The longer you remain invested in a Roth 401(k), the more you are likely to benefit from tax-free growth. If tax-free withdrawals could potentially benefit you, and your employer makes a Roth 401(k) available, you may want to consider adding a Roth 401(k) to your retirement planning mix.
Contribution Limits
All 401(k) plans have a contribution limit, which is a maximum amount of money you can contribute to your fund annually. This limit is determined by the IRS and slowly increases year over year. As of 2022, the maximum an individual can contribute is $20,500. If an individual is 50 years or older, they can contribute an additional $6,500 for the year.
If your employer provides a match, it is always recommended to contribute at least the amount that would make you eligible for your employer’s match program, so you can benefit from the additional money your employer pledges to contribute to your retirement fund. Your contribution amount is not fixed and can be adjusted as you wish.
Investments
While most plans will have a default investment option, contributors have the ability to allocate their funds towards various investment opportunities. They will be able to determine how much of their investments will be in riskier stocks and how much will be in “safer” investments, like bonds.
Stocks have the potential for greater returns but can be more volatile than your other investments.
Bonds are more stable but offer potentially lower returns over time your risk appetite may determine your investment decisions. We suggest diversifying your investments with an asset allocation strategy that best matches your risk, return, and time horizon goals.
Employer Matching
When it comes to employer matching, there are 4 different options that an employer can choose from when contributing to an employee’s 401(k) program:
- 100% Matching: Your employer contributes the same amount of money that you contribute, up to the federal limit.
- Partial Matching: The employer will match up to 50% of your salary.
- Percentage Matching: Your employer matches a percentage of your contributions. For example, if your employer matches 25% of your contributions and you contribute $1000 to your 401(k) fund, your employer would contribute $250. In this type of plan, it is suggested to contribute more money each year to maximize your employer match.
- Dollar Amount Matching: Your employer contributes up to a certain dollar amount. For example, if your employer offers to match up to $4000, you can still contribute over that amount, but your employer will only match up to $4000. In order to receive the maximum employer contribution, you must contribute the maximum amount that your employer pledges to match.
401k Withdrawals
You can withdraw from your 401(k) fund if:
- You retire
- You die (in which case your family may be entitled to some of your 401(k) funds)
- You become disabled
- You reach age 59 ½
- You suffer an extreme or unusual hardship
- Your 401(k) plan is terminated
Disclaimer: 401(k)’s are intended to be held until retirement and account holders will face fees if funds are withdrawn prior to retirement.
What happens to your 401k if you decide to leave your job?
You can move your 401k plan to a new employer. If you move to a different employer which also offers a 401(k) plan, you can roll the full balance of your 401(k) with your former employer over to a new account. There might be an administrative fee, but there will be no penalty for moving your funds.
You can keep your 401k plan with your former employer. Depending on the plan in place, a former employee could leave their funds with their current provider even if they no longer work with the company. However, the former employee would be subject to the rules of their past employer regarding investment options.
You can withdraw your funds. If a former employee would like to withdraw their 401(k) funds from their former employer’s 401(k) plan, potential fees and penalties may apply.
Now that you are an expert on 401(k), check out our Beginners Guide to Open Enrollment to prepare for the 2023 Open Enrollment season this November. Good luck and happy saving!
