A 401(k) plan can be incredibly valuable in planning your retirement. Here's what you need to know about them.
401(k) retirement plan
A 401(k) - named after a section of the Internal Revenue Code - is a retirement savings plan sponsored by your employer that allows you to contribute pre-tax dollars and defer taxes on any growth of your investment. (Taxes are paid when you withdraw the money.) It also allows your employer to match a specified percentage of your contributions into the plan. Some employers will make you wait a certain amount of time (three months, for example) before you can start participating in a 401(k).
How does it work exactly?
It's important to know your employer does not invest your money for you. Your employer's role is to take your payroll deduction, put it into an account and select an investment manager who will invest your money. Typically, your HR department will provide you with information on your plan's investment manager and the investment products they offer.
The kinds of investments you make are up to you, but usually most plans will let you select from several different mutual funds. If you have no idea where to start, don't worry. Your plan's investment manager can break it down into much simpler terms.
For instance, there might be a choice of mutual funds for people who have long-range retirement goals and have several years to go before retiring. On the flip side, there might be a group of funds designed for individuals less than 10 years away from retirement.
The benefits of a 401(k)
There are plenty of benefits to having a 401(k), so much so that a recent survey showed that 89 percent of employees who are offered a 401(k) will participate in it. Here are just a few of the pluses:
- Employer match: Imagine getting free money from your company. That's essentially what an employer match is. Employers often make matching contributions for employees who contribute to the plan. For example, an employer might contribute 50 cents for each dollar that participating employees contribute. Every little bit helps.
- Automatic contributions: When you have your funds taken out of your check automatically, you'll be more inclined to participate. On day one of your job, find out if you're enrolled automatically and how much of your base pay goes into the account (and raise it if you can). You'll be grateful tomorrow for what you put in today.
- Pre-tax contributions: A huge benefit of a pre-tax retirement savings account is that it can reduce your taxable income today, so you won't have to pay taxes until you withdraw your money in retirement.
- Retirement savings-boost: Many people think that Social Security will provide the bulk of their retirement funds. While Social Security will help, every little bit - including 401(k) investments - can help secure you a comfortable life in retirement.
A 401(k) has a maximum annual employee contribution limit set by the IRS each year: If you're under 50, the limit is $19,000; if you're over 50, the limit is increased by an additional $6,000. These figures exclude matching funds, so in 2018, your total 401(k) contributions (from yourself and your employer) cannot exceed $56,000. This figure rises to $62,000 for those 50 or older.
Generally, the IRS states that distributions of elective deferrals cannot be made until:
- You die, become disabled or have a severance from your employer.
- The plan ends without a replacement.
- You turn 59½ or incur financial hardship.
Life happens. If you ever need access to your retirement savings early, you're generally permitted to take a loan out, although there are disadvantages in doing so. Below are a few common rules about plan loans:
- Half your balance: You're eligible to borrow as much as 50 percent of your vested account balance up to $50,000.
- Five years for repayment: Typically, borrowers need to make loan payments at least quarterly and pay back the entire balance within five years.
- Changing jobs triggers a due date: If you quit your job or get laid off, your loan will be due sooner. The outstanding balance must be rolled over to a new plan prepaid by the due date of your federal income tax return.
- Watch out for fees: Although you are borrowing your own money, you might be charged origination, administration and maintenance fees. And, of course, interest.
Rolling over your 401(k)
What should you do with your 401(k) if you change jobs? You've probably heard the term “roll over." By rolling over, the funds in your 401(k) transfer to a new IRA and won't be taxed if done in accordance with IRS rules.
Additional investments for retirement income
In addition to investing in a 401(k) Plan, annuities are another great way to potentially boost your retirement income. And if you still feel overwhelmed, contact your HR department or your investment manager for guidance. Most investment managers have websites that allow you to review your 401k account and learn more about your investment choices.
If you have very specific questions or need more assistance, a financial advisor can help you evaluate your options for meeting your retirement objectives and goals. Visit the Protective Life Learning Center for more retirement guidance.
Annuities are intended as vehicles for long-term retirement planning, which is why withdrawals reduce an annuity's remaining death benefit, contract value, cash surrender value and future earnings. Annuities may also be subject to income tax and, if taken prior to age 59 ½, an additional 10% IRS tax penalty may apply. Product guarantees are backed by the financial strength and claims-paying ability of the issuing company.