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10 Things You Need To Know About 401k Plans

Everyone has heard of a 401k plan.   A 401k plan is considered by many to be the best plan an employer can offer, making it the most popular.  While a 401k retirement plan is the most popular, that does not mean that it is straightforward, it is in fact quite complex and has many rules and regulations.  

401k

 

What exactly is a 401k retirement plan?

A 401k plan, and its counterpart for non-profit employers called a 403b, is a retirement plan that you can choose to participate in through your employer.  Participation in a 401k plan means that your employer will contribute a predetermined part of your paycheck into your 401k account.  Upon signing up for a 401k, you will be given investment options and it is up to you to choose the option that suits your life goals and tolerance for risk.

 

10 Rules About 401k Plans

    • Contributions to your 401k come from payroll deductions.  This is the only way money can be moved into a 401k, which can make it easier for some to save.

 

    • There is an annual limit.  For 2011, the maximum contribution that can be made to your 401k is $16,500, but if you are over 50 you can contribute up to $22,00.  It is important to note that even if you have a second job, the sum of the contributions made at both jobs is what is considered in the contribution cap.  

 

    • With a 401k employers can match contributions.  Each employer will likely have a slightly different 401k set-up along with different ways of matching your contributions.  A typical match could be 50% of the first 6% of your salary you contribute to your 401k.   


    • Contributions to a traditional 401k plane are tax-deductible. Since contributions are made on a pretax basis, you do not have to pay a dime in income tax on what you contribute.  Also, you do not have to pay any taxes on investment gains until withdrawals from your plan are made.  It is also important to note that contributions are still subject to Social Security, federal unemployment and Medicare taxes.


    • Contributions to a Roth 401k are not tax-deductible.  Some employers are adding a Roth feature to the 401k plans they are offering employees.  This feature allows you to make contributions on an after-tax basis, so these contributions do not have an upfront tax benefit, but distributions are tax-free.  In other words, if your Roth increases in value substantially, you could save a small fortune by not having to pay a tax on the growth of your 401k account. 


    • There is also the option to contribute to an IRA.  Some people don’t realize that by participating in a 401k program you are not barred from contribution to an IRA.  While your income may limit your ability to do so you could potentially contribute the maximum for your 401k as well as your IRA in the same year.

 

    • All of the contributions you make to your 401k are 100% vested.   Upon leaving your job, you can take your accumulated 401k funds with you.  Regardless of whether you choose to leave your job or are let go, your retirement money is safe, but the matched funds contributed by your employer could be subject to a vesting schedule that could mean years before you fully own those additional funds. 

 

    • You can be penalized for early or late withdrawals from your 401k.  It is crucial to understand that a 401k account is not like an regular savings account, there are time constraints on the account.  If you withdraw funds from your 401k before the age of 59 1/2, you may have to pay a penalty of 10%.  Also, if you reach the age of 70 1/2 or choose to retire at an older age, you must start taking required minimum reductions (RMD) or face additional penalties.  

 

    • Some plans allow for hardship distribution.  Hardship withdrawals from a 401k account may be permitted if you need to prevent a foreclosure, pay for medical bills, a funeral or college.   If you meet the criteria for a hardship distribution, it will still be considered an early withdrawal and likely subject to the 10% penalty.  

 

    • You could be able to borrow from your 401k account.  Depending on your 401k plan, you may be allowed to take an interest-bearing loan from your 401k for half of your account balance up to $50,000.  
 
Since employers have some choice in how they design the 401k plans they offer, they can be quite complex.  While each 401k plan may be slightly different it is still worthwhile to learn about the plan your employer offers since they can come with great tax benefits and savings.  
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