Facts About Your 401k

If you work in the private sector, you have probably heard of a 401k plan. However, you might not know what it is, how it works, or why you invest. Today, we're going to be filling you in on facts about your 401k that you may not know: 

1. What is a 401k?

A 401k is an employer-sponsored defined contribution plan. Sound like a mouthful? It is. Here's what it means:

  • You can only get a 401k through your employer. You cannot open one up at a bank or through your advisor. (employer-sponsored)
  • You put in your own money instead of your employer putting in their money (defined contribution (401k) vs. defined benefit (pension))
  • Your employer will generally contribute or match a percentage of your paycheck 

2. HOW MUCH CAN YOU CONTRIBUTE?

You can contribute up to $18,000 a year to your 401k. If you are over 50, you can contribute an additional $6,000 a year. Compared to an IRA, this is a hefty sum. In addition, most employers offer a match and this means free money! They usually have a percentage they are willing to match up to as a percentage of your paycheck. Check out your company's 401k provider for more information. 

3. WHEN CAN YOU TAKE YOUR MONEY OUT?

One downside of your 401k is the amount you are taxed if you redeem your funds. If you are under 59 1/2 and have a normal 401k, you will have to pay ordinary income tax plus a 10% fee. This means, your funds can be taxed up to 40%. Yikes! If you are planning on using funds for something else besides retirement, try to factor this into your amount before you contribute. 401k's are designed for retirement only so take that into account. You also will have to take a required minimum distribution after the age of 70 1/2. 

4. There are two types

Previously, the only type of 401k available was pre-tax. Now there are Roth 401k's that are available and many employers are utilizing them. The contribution limit with a Roth 401k is the same but the tax is taken out beforehand equalling a larger dollar amount contributed per year. This is the perfect option for high income earners that are looking to save more money in retirement and are no longer qualified for a Roth IRA. 

5. They are not perfect

Although 401k's are not the perfect investment vehicle, they are still worth investing in. They can have high fees, few investment options, and some pretty grueling redemption limits. However, no other investment will be able to offer such a high contribution limit and also be tax deductible. Please beware the fact that your money will be tied up for years to come and adjust your contribution accordingly.

Are you happy with your company's 401k? Did you learn something new about them? Comment below!