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 in it. Today, I'm going to be filling you in on facts about your 401k that you may not know and hopefully convince you that investing in one is worth your while:
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
In layman's terms, it is a retirement plan that is only accessible through your employer.
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 for a grand total of $24,000. Compared to an IRA, this is a hefty sum. Also, most employers offer a match, and this means free money for you! Employers 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 taxed if you redeem your funds. If you are under 59 1/2 and have a regular 401k, you will have to pay ordinary income tax plus a 10% fee. This means, your funds can be taxed up to 40% for premature distribution. Yikes! If you are planning on using funds for something else besides retirement, try to factor this into your budget outside of your contribution. One of the worst things you can do for your retirement is to take funds out of your account before you need them. 401k's are designed for retirement only; they should not be your only savings plan. Also, you will have to take what is known as a required minimum distribution after the age of 70 1/2. As you can see, 401k's have many rules. You may want to familiarize yourself on them before you contribute an amount you cannot get out.
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 more considerable 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. You may have multiple
If you leave a job, understand that you have options on what to do with that 401k. Due to the fact most private companies offer 401k programs, you can either transfer your 401k to your new company, keep it where it is, or move it to an IRA. I've written an entire article dedicated to this subject that can be found here.
6. They are not perfect
Although 401k's are not the perfect investment vehicle, they are still worth the investment. 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!