401k Basics

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

What is a 401k?

A 401k is a retirement savings plan sponsored by an employer. It allows employees to save and invest a portion of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.

How Does a 401k Work?

  1. Employee Contributions: Employees choose a percentage of their salary to contribute to their 401k. This money is deducted from their paycheck before taxes.
  2. Employer Match: Many employers offer a match to employee contributions up to a certain percentage.
  3. Investment Options: The money contributed can be invested in various assets like stocks, bonds, and mutual funds.
  4. Tax Benefits: Contributions are made pre-tax, reducing taxable income. Taxes are paid when withdrawals are made, typically after retirement.
  5. Withdrawal Rules: Generally, you can start withdrawing without penalties after age 59½. Early withdrawals may incur penalties.
  6. Contribution Limits: There are annual limits to how much you can contribute.

401k Benefits

  • One of the significant benefits of a 401k is that employee contributions are made on a pretax basis, reducing the income tax the employee owes.
  • In addition, the 401k earnings grow tax-deferred, meaning they are not taxed until withdrawn from the account. Withdrawals from a 401k are also subject to income tax but are usually taxed lower than regular income.
  • Another benefit of a 401k is that many employers offer a matching contribution, which can be an excellent way to boost retirement savings.
  • Finally, 401ks often have lower fees and expenses than other investment accounts.

All of these factors make a 401k an attractive option for retirement savings.

401k Contribution Limits (2024)

In 2024, 401k contribution limits are:

Elective employee deferral$23,000
Catch-up contribution limit (age 50 or older)$7,500
Limit on additions to defined contribution plans$69,000
Annual benefit limit on defined benefit plans$275,000
Highly compensated employee$155,000
Maximum compensation taken into account for qualified plans$345,000

401k Plan Types

There are two types of 401k plans: traditional and Roth.

  • With a traditional 401k, your contributions are made with pretax dollars, and you pay taxes on the money when you withdraw funds in retirement.
  • With a Roth 401k, your contributions are made with after-tax dollars, but the after-tax contributions grow tax-free, and you don’t have to pay taxes on it when you withdraw it in retirement.

Which type of 401k is suitable for you? That depends on your circumstances.

  • If you think you will be in a lower tax bracket in retirement, a traditional 401k may be the better choice.
  • If you think you will be in a higher tax bracket in retirement, a Roth 401k may be the better choice.

Employer Contribution Match

If you have a 401k plan through your employer, you may be able to take advantage of employer contributions. This is when your employer matches a certain percentage of your contributions up to a certain amount.

For example, if your employer offers a 50% match on contributions up to $2,000 per year, and you contribute $2,000 to your 401k, your employer would contribute an additional $1,000. Employer contributions are a great way to boost your retirement savings!

Self-Employed 401k

If you’re self-employed, you can still set up a 401k plan called a solo 401k. However, some different rules and regulations apply to self-employed 401k plans, so research before setting one up.

What Happens To 401k When You Quit?

When you leave your job, you have a few options for what to do with your 401k. You can withdraw the money, roll it into an IRA, or leave it with your former employer. Each option has its pros and cons.

Withdrawing Money From Your 401k

Withdrawing the money may be tempting, but it’s not always the best choice. You will have to pay taxes on the money and may also be hit with an early withdrawal penalty. If you need the money immediately, withdrawing it may be your only option. But if you can afford to wait, rolling it over into an IRA or leaving it with your former employer may be better.

Rolling Over Your 401k Into An IRA

You won’t have to pay taxes on the money until you withdraw it, and you can keep growing your retirement savings tax-deferred. However, there are some drawbacks to rolling over your 401k. For example, you may have to pay fees to the financial institution to set up an IRA account. And if you withdraw (not roll over) the money before age 59 1/2, you’ll still be subject to taxes and early withdrawal penalties.

Leaving Your 401k With The Former Employer

Leaving your 401k with your former employer may be the best choice if you’re happy with the investment options and fees offered by the plan. Another advantage of leaving your 401k behind is that you won’t have to pay taxes on the money until you withdraw it. However, there are some potential drawbacks to this option as well. For one thing, you won’t have as much control over your retirement savings. And if your former employer goes out of business, your 401k could be lost or substantially reduced in value.

Is The 401k A Good Investment?

Many people view their 401k as a retirement account and nothing more. However, 401ks can be much more than that.

  • For starters, 401ks offer tax benefits that other investment options don’t. With a traditional 401k, employee contributions are made with pretax dollars, which means they’re not subject to income taxes. In addition, employer matching contributions are also tax-free.
  • Furthermore, 401ks grow tax-deferred, meaning you won’t have to pay income taxes on any investment gains until you withdraw money from your account. This can be a significant advantage, especially if your investment portfolio has performed well.
  • In addition to tax benefits, 401ks also offer the opportunity for employer matching contributions. If your employer offers a match, it’s essentially free money that you can use to grow your retirement savings. Employer matching contributions can be a potent tool for building retirement savings, so it’s worth taking advantage of if your employer offers it.

401ks are a great way to save for retirement while enjoying some tax advantages. If you can participate in a 401k, it’s worth considering.

How does your 401k grow?

A 401k is a retirement savings plan sponsored by an employer. It allows employees to save and invest for their retirement tax-deferred. Investment earnings in the account grow tax-deferred, meaning you will not pay income taxes on the money until you withdraw it from the account at retirement.

How much does a 401k grow?

Employees have a wide variety of investment choices within their 401k plans. These investment choices will affect how fast the account balance grows and how much risk is involved. Many choose to invest in different investments to balance risk and potential earnings. Contact an advisor for investment advice within your plan.

Can I lose money in 401k?

It’s important to remember that all investing involves risk, including the possible loss of principal invested. In addition, no one can predict precisely how the markets will perform in the future, so it’s vital to get professional advice to ensure that the investment choices are appropriate for the individual’s risk tolerance and financial goals.

What Are The Pros And Cons Of A 401k?

  • Employees can defer a portion of their salary into the account, and the money is tax-deferred until it is withdrawn at retirement. This means that employees can save more for retirement than they would be able to with other savings plans.
  • 401k plans often offer catch-up contributions for employees over 50, which allows them to save even more money for retirement.
  • 401k plans may offer a tax deduction for employee contributions. This tax break can help to lower an employee’s tax bill and increase their take-home pay.
  • 401k plans have an annual contribution limit. However, this may not be enough to fund a comfortable retirement, especially if you start saving late.
  • 401k plans can result in higher taxes in the future. This is because the money you contribute is not taxed at the time of contribution. However, it is taxed when you eventually withdraw it in retirement. This could create a significant tax burden, mainly if you are in a higher tax bracket at the withdrawal time.
  • 401k plans can be subject to fees and restrictions, affecting your savings.
  • Required minimum distributions must be withdrawn starting at age 73.

Is A 401k Worth It Anymore?

Many people today wonder whether a 401k is worth it anymore. After all, with all the stock market fluctuations and no guarantee of retirement income, it’s hard to know whether it’s worth investing in a 401k.

However, non-qualified annuities can offer a guaranteed retirement income, and fixed index annuities offer protection from losing money with minimal fees.

In addition, fixed index annuities offer premium bonuses that mimic the employer contribution match, and these bonuses are often higher than what an employer will match.

Plus, only the interest will be taxed in the future, reducing your income tax obligations.

Roth IRA annuities will also guarantee your future retirement income and all withdrawals will be free of income taxes for the rest of your life.

How Much Should I Contribute To My 401k?

If your employer offers a full match on contributions up to a certain amount, you should always contribute at least enough to get the full employer match. This is essentially free money, so it’s worth taking advantage of.

Do You Pay Taxes On A 401k Withdrawal?

The answer is maybe. It depends on how your 401k is structured and what kind of withdrawals you make. Under the internal revenue code, most 401k withdrawals are subject to ordinary income tax. However, if your 401k is set up as a Roth IRA, your withdrawals are usually tax-free.

How Much Can I Withdraw From My 401k?

When workers reach retirement age, they can withdraw the money from their 401k and use it to fund their retirement. There are some restrictions on how much workers can contribute to their 401k each year, but there is no limit on how much they can withdraw. Plan participants can typically begin qualified distributions at age 59 1/2, but they may be subject to taxes and penalties if they withdraw the money before retirement age

401k Alternatives

Many retirement savings plans are available; the best depends on your circumstances. Some other popular retirement savings plans include IRAs, pension plans, and annuities.

IRA

An IRA (Individual Retirement Account) is a retirement savings account you set up yourself. There are two main types of IRAs: traditional and Roth. With a traditional IRA, your contributions are made with pretax dollars, and you pay income taxes on the money when you withdraw it in retirement. With a Roth IRA, your contributions are made with after-tax dollars, but the money grows tax-free, and you don’t have to pay income taxes on it when you withdraw it in retirement.

Pension

A pension plan is a retirement savings plan offered by an employer (defined contribution plan). Pension plans are becoming less common, but some employers still offer them. First, your employer contributes to the plan on your behalf with a pension plan. Then, when you retire, you receive a monthly payment from the pension plan based on your years of service and salary.

Deferred Annuity

A deferred annuity is an insurance product that can be used for retirement savings. With an annuity, you make contributions (with no limits) to the annuity over time. The money then grows tax-deferred, and you can start taking withdrawals when you reach a certain age (usually 59½).

Indexed Universal Life Insurance

Indexed universal life insurance is a type of permanent life insurance that can also be used for retirement savings. With indexed universal life insurance, you contribute to the policy over time. The money in the policy then grows based on the performance of an index, such as the S&P 500. In addition, you can take tax-free withdrawals from the policy starting at age 59½, and the death benefit is tax-free to your beneficiaries.

Many retirement savings plans are available, so be sure to research to find the best one for you. A 401k plan is an excellent option for many people, but other options are available if a 401k doesn’t fit your needs. Talk to a financial advisor for more information about your retirement savings options.

IRA Vs. 401k

IRA stands for Individual Retirement Account. An IRA is a personal account that you open with a financial institution. You can choose to invest in a traditional IRA or a Roth IRA.

  • With a traditional IRA, your pretax contributions are tax-deductible and grow tax-deferred.
  • With a Roth IRA, your contributions are not tax-deductible, but the earnings grow tax-free.
  • IRAs may offer better interest rates than 401k.
  • IRAs tend to have lower contribution limits than 401ks, but they offer more flexibility in using your money.

A 401k is an employer-sponsored defined benefit plan.

  • With a 401k, you contribute pretax income to your employer’s account.
  • With a 401k, your employer often matches some of your contributions, whereas an IRA offers no such employee benefits.
  • One downside of a 401k is that they typically have more limited investment options than IRAs.

Learn more about IRAs to see if they are a fit for you.

Tips For Saving For Retirement

Saving for retirement can be a challenge, but there are some things you can do to make it easier. Here are a few tips:

  • Start early. The sooner you start saving for retirement, the more time your money has to grow.
  • Save regularly. Try to make saving for retirement a habit by setting up automatic contributions to your retirement account.
  • Save as much as you can. The more you save now, the less you’ll worry about later.
  • Invest wisely. Be sure to diversify your investments to help reduce risk.
  • Save with tax-advantaged plans. Taxes are most likely only going up in the future. So save with retirement plans that reduce the tax bill in future retirements, like a Roth IRA, non-qualified deferred annuity, or life insurance policy.
  • Take the guesswork out of your retirement. Annuities are the only retirement plan that can tell you exactly how much you need to save today to reach tomorrow’s retirement income goals.

Saving for retirement can be challenging, but starting early and saving as much as possible is essential. So contact us today to get started on the right track.

Things To Consider Before Retirement

There are a few things you should consider before retirement:

  • How much money will you need to have saved?
  • When do you want to retire?
  • What will your retirement lifestyle be like?
  • Do you have any other sources of income in retirement?
  • What are your health insurance needs in retirement?
  • Have you considered long-term care insurance?

Common 401k Mistakes

There are a few common mistakes people make when planning for retirement:

  • They don’t start saving early enough.
  • They don’t save regularly.
  • They don’t save enough money.
  • They invest too conservatively.
  • They don’t have a plan.

These are just a few common mistakes people make when planning for retirement.

How To Withdraw Money From A 401k After Retirement

As you approach retirement, it’s essential to consider how you will generate income. Social Security will provide some income, but it won’t be enough for many people to cover all expenses. One option to consider is rolling your 401k into an IRA annuity with a guaranteed lifetime withdrawal benefit. This type of annuity provides a reliable income stream that can last for the rest of your life. The fixed payments are based on the value of your account at the time of retirement and will never decrease for as long as you live. With a little planning, you can ensure you have the income you need in retirement.

Free Tool: 401k Calculator

Retirement Planning Resources

There are a few resources that can help you plan for retirement:

  • The Social Security Administration’s website.
  • The Internal Revenue Service website.
  • Your state’s pension and retirement plan websites.
  • 401k companies have their own resources.
  • Your employer’s human resources or benefits department.
  • Financial planning websites like The Annuity Expert.
What Is A 401K, And How Does The Retirement Plan Work

Next Steps

It’s never too early or too late to start saving for retirement. No matter your age, it’s essential to have a plan to enjoy a comfortable retirement later on. If you haven’t started saving yet, don’t worry – plenty of options are available. Contact us today, and we can help you create a retirement savings plan that fits your needs and goals. And remember, the earlier you start saving, the more time your money has to grow!

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Questions From Our Readers

What is the 401k definition?

A 401k plan is a tax-advantaged, defined-contribution retirement account offered by many employers to their employees. It is named after a section of the U.S. Internal Revenue Code.

What is a 401k?

A 401k is a retirement savings plan offered by employers in the US, allowing employees to save and invest a portion of their pre-tax salary for retirement. Contributions are tax-deferred, meaning taxes are paid upon withdrawal. Employers often match a percentage of the employee’s contributions up to a specific limit. Investment options within a 401k plan typically include a mix of stocks, bonds, and mutual funds. Upon reaching age 59.5, withdrawals can be made without incurring a penalty.

Can I contribute 100% of my salary to my 401k?

In 2024, the maximum contribution is $23,000 for employees under 50. If you’re 50 or older, you can make a catch-up contribution of up to $7,500 for a total potential contribution of $30,500.

How do I find my 401k from an old job?

The first step is to contact your previous Human Resources department. They will be able to provide you with information about how to access your account and make withdrawals. If you are no longer in touch with your previous employers, you can also contact the financial institution that manages the account. Again, they will be able to help you get in touch with the right people and start accessing your account.

What is better than a 401k?

Many people think that a 401k is the best retirement account to have. However, several retirement accounts are better than a 401k. One of these is a Roth IRA. With a Roth IRA, your contributions are made with after-tax dollars, and your withdrawals in retirement are tax-free. This can provide you with significant tax savings down the road. Another retirement account option is a non-qualified annuity. With this type of account, you can put away money on a tax-deferred basis, and you will only pay income taxes on your investment growth when you start withdrawing in retirement. This can provide you with significant tax savings as well.

What happens to 401k when you quit?

When you quit a job, your 401k stays intact, but you have several options. You can leave the account with your previous employer, roll it over into a new employer’s 401k plan or an Individual Retirement Account (IRA), or cash out, which incurs taxes and potential penalties if you’re under 59.5 years old. Evaluating each option’s pros and cons is essential, considering factors such as investment choices, fees, and tax implications before deciding.

How much can a 401k earn?

The earnings potential of a 401k depends on factors like investment choices, contribution amounts, and time horizon. Investments in a 401k typically include a mix of stocks, bonds, and mutual funds, each with varying levels of risk and return. While historical stock market returns have averaged around 7% annually after inflation, individual returns can vary greatly. Consistently contributing and taking advantage of employer matches while adopting a diversified investment approach can maximize the growth potential of your 401k.

How much should I have in my 401k?

The amount you should have in your 401k depends on factors like age, income, retirement goals, and living expenses. A common rule of thumb suggests having 1x your annual salary saved by age 30 and an additional 1x for every five years after that (3x by 40, 6x by 50, and so on). However, individual circumstances may require different savings targets. Regularly reviewing your financial situation, using retirement calculators, and consulting with a financial advisor can help determine the right amount.

How can I take a loan from my 401k?

First, to take a loan from your 401k, ensure your plan allows loans by reviewing its terms or contacting the plan administrator. You’re generally eligible to borrow up to 50% of your vested account balance, with a cap of $50,000. It’s crucial to understand the loan’s terms, including the repayment schedule, interest rate, and applicable fees. You can submit a loan request usually online or through your plan administrator. Repayment is typically done via payroll deductions and should be completed within 5 years. Remember that failure to repay the loan can lead to taxes and penalties.

If you don’t file for Social Security, do you still need to claim 401k money on Social Security?

If you haven’t filed for Social Security benefits, your 401k withdrawals or income won’t affect them directly. Social Security benefits are calculated based on your earnings record and the age you start receiving them. However, 401k withdrawals can affect the taxation of Social Security benefits once you start receiving them.

How do I withdraw from my 401k?

To withdraw from your 401k, you generally need to contact the plan administrator or access your account through their online portal. First, check if you meet the criteria for withdrawal, such as reaching the age of 59½ or experiencing a qualifying hardship. Then, submit a withdrawal request form specifying the amount you wish to withdraw. Be aware of potential taxes and penalties, especially under 59½. The processing time and specific procedures can vary depending on your plan’s rules.

Can I take my 401k to my bank and then open an IRA account?

Yes, you can take your 401k funds to your bank and open an Individual Retirement Account (IRA). This process, known as a rollover, involves moving funds from your 401k into an IRA without incurring immediate taxes or penalties. It’s important to ensure the transfer is done correctly, usually as a direct rollover, where the funds are transferred directly from the 401k to the IRA. If the funds are given to you to deposit into the IRA, completing the deposit within 60 days is crucial to avoid taxes and penalties.

Is moving 401k stock to bonds because I am close to retirement a good choice?

Shifting from stocks to bonds in your 401k as you approach retirement can be a sensible strategy for many. The rationale behind this move is to reduce the risk of your portfolio (Sequence of Returns Risk). Stocks generally offer higher growth potential but come with greater volatility, which can be risky as you near retirement when you have less time to recover from market downturns. Bonds are typically seen as more stable and provide more predictable income, which aligns with the need for security in retirement.

Do I need to be retired to withdraw from 401k if I am 60?

Do you need to be retired to withdraw from a 401k if you are 60 years old? No, you do not need to be retired to start withdrawing from your 401k at age 60. While the typical age for penalty-free withdrawals from a 401k is 59½, being employed or retired isn’t a factor for withdrawing funds at or beyond this age. However, remember that while you can avoid the 10% early withdrawal penalty, the withdrawals will still be subject to ordinary income tax.

How do I roll over my 401(k) to my IRA?

To roll over your 401(k) into an IRA, contact your 401(k) plan administrator and your chosen IRA provider. Request a direct rollover to avoid taxes and penalties; this way, the funds transfer directly between accounts without you touching the money. Your 401(k) administrator will guide you through their process and provide the necessary forms. Make sure to specify the type of IRA (traditional or Roth) for the rollover. It’s important to check for any potential fees or tax implications, especially if rolling over to a Roth IRA, as this could involve a taxable event.

At 66 years old, can you start taking money out of your 401(k) without penalty?

Yes, you can. Once you reach the age of 59½, you are allowed to withdraw money from your 401(k) without facing the 10% early withdrawal penalty. Since you are 66, you are well within the age range to start taking distributions. Additionally, starting at age 73, you are required to take minimum distributions (RMDs) from your 401(k) as per IRS regulations.

Can you access your old 401(k) if you move to another state?

Yes, moving to another state does not affect your ability to access your old 401(k). Your 401(k) is linked to your employment, not your state of residence.

My employer switched companies for our 401k investment. Now I can’t access my money. Please help

This is known as a blackout period. A blackout period is a time when the company handling your 401K, like Vanguard or Fidelity, is making big updates to the plan. During this time, you can’t do anything with your 401K—like changing where your money is invested, taking money out, or changing who gets your 401K if something happens to you. This could happen if your job is switching the 401K from one company to another, like from Vanguard to Fidelity. Basically, it’s a freeze on your 401K when important changes are being made.

How does a 401k grow?

A 401(k) grows through contributions from your paycheck and often, employer matching funds. Investing these contributions in stocks, bonds, and mutual funds allows potential growth over time, benefiting from compound interest. Growth rate depends on contribution levels, investment choices, and market performance. Withdrawals are taxed as income in retirement.

How does a 401k work?

A 401(k) is a retirement savings plan employers provide their employees. This plan lets employees save and invest a portion of their salary before taxes are taken out. Taxes are paid when the money is withdrawn during retirement. Additionally, many employers offer to match the amount contributed by the employee to help the account grow faster.

I need a lump sum of money now. Is it possible to borrow from my 401k? I have $200,000 in there. 

The ability to withdraw from a 401K is determined by the plan administrator, but generally, you can access the funds. It’s important to keep in mind that if there is a company match, you may not be able to access the funds at 100% since there is a vesting schedule for what the company matches. Also, depending on your age, you may have additional tax penalties, especially if you’re under age 59.5.
If you are interested in learning how to minimize the taxes and penalties by moving the funds to an annuity with a bonus and then withdrawing them, we’re happy to assist you with that as well.

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Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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