Only need coverage for 10 to 30 years? Get a free quote today. Start here >
Don't know what type of insurance you need? Start here. Or call us at 1-844-733-5433. Learn more >
Want affordable coverage for your child? Get a free quote today Get started>
For many Americans, a 401k is the key to their retirement planning. Still, many workers don’t understand how these plans work. To make sure you’re prepared, we’ve outlined the most important information about a 401k plans.
invest in a 401k, you need to work at a company that offers one, or be the sole
proprietor of a business (with no employees) and participate in an individual
401k. You can’t open a 401k if you are unemployed.
Once you’re in a company-sponsored
401k, your company will tell you what percentage of your salary you can put
away per year into the company plan. Some companies may also match your contributions.
For example, a 401k plan might let you invest a percentage of your salary each year and your company would match 50 cents for every dollar you add to your account up to three percent of your salary. The company match is free money, and it’s usually a good idea to invest the full percentage of the match.
Your company will tell you the maximum percentage of your
salary you can add to the 401k each year. However, the government also limits
how much you can invest in a 401k. As of 2015, you can add up to $18,000 a year to your account if you are
younger than 50 and up to $23,000 if you are 50 or older. Each year, you can
contribute the lesser of the plan’s maximum percentage or the government
The money in your account will be a mix of the contributions from your pretax earnings and your company’s matching contributions, assuming your company offers that benefit. Your pretax earnings come out of your paycheck and will remain your money even if leave your job. The company match is a bit less certain. Many companies have restrictions on when the matching contributions actually become yours. This is called vesting. You usually need to stay with the company for a minimum number of years or else you could lose some or all of your matching contributions.
The money added to your 401k can be deducted from your taxable income. This
helps you tackle two important financial goals: saving for the future while
also bringing down your current tax bill.
Once your money is in a 401k, you’ll be investing it in a variety of stocks, bonds, mutual funds and other investments. Typically, when you invest, you need to pay taxes on your investment earnings right away. Not with the 401k. As long as you keep your savings in this account, you can put off paying taxes on these gains until retirement.
401k is a retirement plan so you are supposed to keep your money in the plan
until you reach a certain age. If you leave your job, you can start taking penalty-free withdrawals
from your 401k as soon as you turn 55. If you keep working past this age, you
can start taking penalty-free
withdrawals once you turn 59½.
When you take a retirement withdrawal, you’ll need to pay income tax on that amount.
Taking money out of your 401k before retirement can be difficult. First, your company plan needs to allow early withdrawals. Then, it gets expensive. The IRS charges an extra 10 percent penalty on top of income taxes on early 401k withdrawals. The penalty can be avoided in a few situations, such as paying for excess medical bills or college tuition.
You might also be able to take money out as a loan. When you take out 401k loans, you won’t owe taxes or a penalty provided you pay the money back into your plan with interest. Once again, whether you can take a loan depends on your company’s 401k withdrawal rules.
If you leave the company offering the 401k, you won’t be
able to add any more money to its plan. In this situation, it usually makes
sense to take your retirement savings out the door with you, through an account
rollover. When you roll over your old 401k, you transfer the account straight
into another retirement plan, like an IRA or your new job’s 401k, if allowed by your new
employer. You won’t owe any taxes on the move and can get right back to
work investing as normal.
Managing a 401k takes some work but for most people, it’s an important piece of saving for retirement. If you have questions, about this financial tool, consult a financial advisor.
All Learning Center articles are general summaries that can be used when considering your financial future at various life stages. The information presented is for educational purposes and meant to supplement other information specific to your situation. It is not intended as investment advice and does not necessarily represent the opinion of Protective Life or its subsidiaries.
Neither Protective Life nor its representatives offer legal or tax advice. We encourage you to consult with your financial adviser and legal or tax adviser regarding your individual situations before making investment, social security, retirement planning, and tax‐related decisions. For information about Protective Life and its products and services, visit www.protective.com.