Does your employer offer a retirement plan option? Do you contribute to it? Do you understand how it works? I have experienced much confusion about a 401(k) plan. If your employer provides one, or if you are an employer considering adding one, look over this quick guide for common areas of confusion.
- What is a 401(k)?
A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck with tax advantages. 401(k) is named for the tax code that governs them, arose during the 1980s as a supplement to pensions. The money added to a 401k plan is voluntary on the part of employer and/or employee. A 401(k) retirement plan is an optional benefit provided by many employers.
2. What are the tax advantages?
The traditional 401(k) plan gathered money(contributions) directly from the employee’s paycheck before taxes are taken out. This “pre-tax” contribution reduces the amount of the paycheck that is taxable, thus reducing taxable income. The taxes on this money are paid as it is withdrawn in retirement. The Roth 401(k) works in reverse. The money that you earn today is taxed today. When you put this after-tax money into your Roth 401(k), withdrawals taken after you reach age 59.5 will be tax-free if the account has been funded for at least five years.
3. Who contributes?
A 401(k) retirement plan can accept money either from the employees paycheck and/or the employer. The amount either party adds is based on how the individual plan is written. In any case, there is a maximum amount of money allowed in any individuals account per year as determined by the United States Internal Revenue Service. Not all 401(k) plans gain contributions from employers.
4. How much can be contributed?
Two annual limits apply to contributions:
A limit on employee elective deferrals;
and an overall limit on contributions to a participant’s plan account (including the total of all employer contributions, employee elective deferrals (but not catch-up contributions) and any forfeiture allocations).
The limits for 2019 is $19,000.00 employee deferral under age 50 and $25,000.00 for 50 and over when adding the 6,000.00 catch up provision.
5. What is a match?
A matching contribution is an amount of money added to your 401(k) account by your employer on your behalf. The amount an employer gives varies per company and their plan. Some companies do not add any matching contributions. It is called matching because the contributions your employer makes are based on the contributions you make.
The contributions have 2 parts to the calculation of amounts given. The first portion is what percentage of your contribution is matched- i.e. 100% or 50% of your contribution – 1.00 for 1.00 or .50 for 1.00. The second part of the calculation is the “cap” of how much the employer will give. For example, you employer can offer a 100% match on up to 5% of your income. Always be aware of the percent of match and the cap. This will guide you in knowing how to gain the greatest advantage from your “free money” employer contribution.
Let’s say an employee opts to contribute 5% of their income to their 401(k). At 40,000.00 per year income, the average biweekly check is approximately 1540.00. That is 77.00 per check would be contributed by the employee to the plan.
The employer would add based on their plan requirement, example:
100% match up to 5% of income- 77.00 per pay
50% match up to 5% of income – 38.50 per pay
25% match up to 5% of income – 19.25 per pay
6. Can I withdraw the money I save?
Your 401(k) savings are intended to provide for you in retirement. The IRS has placed a 10% penalty, as well as uncollected income taxes, on any withdrawals placed before age 59 and ½. Some plans may offer loans against your savings, but this option should be researched well and considered deeply before taking this option. The monies set aside in a 401(k) are to be used when you no longer have wages earned. They should be incorporated in your retirement plan.
7. Who gets my money if I die?
A 401(k) requires a named beneficiary. You as the employee can name whomever you want as beneficiary. Some states may require the beneficiary to be your spouse and request a signature by them if you would like to name anyone else.
8. How do I sign up for a 401(k)?
First, find out if your employer offers a 401(k); not all companies offer one. Next, get the name of your plan sponsor (the individual in your company responsible for the plan). Ask the Plan Sponsor the best way to sign up for your plan. You should have a team to assist you-
Recordkeeper- the company who holds the funds of the plan. (Fidelity, Mass Mutual, Principal, Nationwide, etc)
Investment Advisor- the individual who guides in investment selection and is responsible for education on the plan. Your Plan Sponsor should have their contact information.
Plan Sponsor- the company representative in charge of the functioning of the 401(k) plan.
These three individuals should be your guidance team to help you better understand how your plan works and the ways to get the best advantages from it.
9. How do I know if I am saving enough?
Determining the rate of savings in your retirement plan is a personal decision based on your retirement income needs, income sources other than 401(k) in retirement, age of retirement, etc. You can see there are many factors and each participant should determine the rate of savings best for them to assist in achieving retirement goals.
401(k) plans can be very confusing. I have only highlighted the nine most common questions according to my financial services practice. You may very well have greater needs and questions. Please feel free to send questions to firstname.lastname@example.org.
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.