What is a 401(k)?

What is a 401(k)?

Have one?  Here’s how to take advantage of it. 

A 401(k) is a retirement savings plan provided by an employer and allows you to save and invest a portion of your paycheck before taxes (the tax-advantage). The money in a 401(k) has the potential to grow tax free. In retirement, withdrawals are taxed as regular income.

If you work for a public organization, such as a hospital, school, and some non-profits, your employer may offer a 403(b) plan, which is very similar to a 401(k) plan, with a few differences. For tax purposes, the IRS treats a 403(b) similar to a 401(k) plan¹ .

Nearly 80% of America’s workers have access to an employer sponsored plan. Each employer’s plan is unique and has its own features.

Pros

• Most plans offer a variety of available investment choices. You decide how your savings are invested among the available choices.
• Most 401(k) plans offer an employer match. A typical employer match is 3% of your salary (it could be more or less). If you contribute 3% of your salary to the plan, your employer will contribute an additional 3% to your plan. Many people call this free money, because that’s really what it is: your employer contributes additional money above your regular pay to your retirement account.
• Larger annual contribution limits.  For 2017, your maximum contribution is $18,000.² If you are over 50, you can contribute another $6,000 each year (known as a “catch-up” contribution).  Total contributions by both you and your employer can’t exceed $53,000² in any year (not including the catch-up contribution).
• Some plans allow loans. We don’t recommend them. It’s a quick way to derail your retirement.
• Some 401(k) plans offer a Roth option. For many, it’s a good way to save. Especially if you expect taxes to be higher in retirement.

Cons

• In most cases, you cannot access the employer’s matching contributions immediately. This delay is called “vesting” and is the amount of time you must work for your company before gaining access to the employer’s contribution to your 401(k). This is how companies protect themselves against you “taking the money and running.” However, all contributions made by YOU to a 401(k) plan are ALWAYS vested (yours to keep).
• Some plans have a limited investment line-up, which doesn’t allow for many choices.
• Early withdrawals from your 401(k) prior to 59½ will cost you a big tax penalty – 10% plus normal state and federal income taxes.
• Some plans allow loans (both a pro and a con). We don’t recommend them. It’s a quick way to derail your retirement.

Which type of retirement account should you fund first?

• A 401(k) or 403(b) should be first if your employer offers a match. Make sure you get the maximum “free” money from your employer’s match.
• Next, contribute to your Roth IRA or Traditional IRA up to your available limit.³
• Then, contribute more to your 401(k) or 403(b). As much as possible.
• Do you have self-employment income? Consider a SEP IRA or a Solo 401(k).

Each employer’s retirement plan is unique and complicated. If your employer offers a 401(k) or 403(b) plan, give me a call and we can discuss how to maximize it for your Best 2nd Half!

Contact us by email or call the office at (719) 630-0600 to set up an appointment.

Citations

1. https://www.irs.gov/publications/p571

2. https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions

1-417553     #2ndHalfWealth

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The Roth IRA and Roth 401(k) offer a tax deferral on any earnings in the account. Withdrawals from the accounts may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs and Roth 401(k)s. Their tax treatment may change.