Over the past few decades, pension plans have been replaced by 401(k)s as employer sponsored retirement plans. Over 27 million Americans contribute to and rely on 401(k)s as their primary retirement savings. While most people contribute to these plans, most aren’t sure how they work or how they should use them.

What is a 401(k)

A 401(k) plan is a tax-advantaged, defined-contribution retirement account named after a section of the U.S. Internal Revenue Code. Typically sponsored by employers, employees make contributions through automatic payroll deductions and a percentage of contributions are matched by the company.

What are the advantages of a 401(k)?

A traditional 401(k) is a tax-deferred retirement plan. Money is contributed to the account before being taxed, lowering your taxable income. The investment earnings are not taxed until the employee withdraws money from the account, usually at retirement age. Since most people will be in a lower tax bracket at retirement, this will save money on both current and future tax burdens.

Another benefit of a 401(k) is employer matching. Most companies will match a percentage of your income if you contribute at least the same amount. Since both worker and employer funds are contributed, overall savings is increased.

Dollars contributed to the 401(k) are then invested in mutual funds and stocks. As the money grows, it is continually reinvested, free of taxes.

How is a 401(k) managed?

401(k)s are generally self-directed. While the employer chooses the administrator of the plan along with some advisory services, employees decide how the money is invested. The plan administrator offers a list of funds and employees choose how to allocate contributions. This allows control over investment aggressiveness.

Are their limits to how much can be contributed?

The maximum you can contribute to a 401(k) throughout the year is revised by the IRS yearly. The contribution limit for 2021, is $19,500. The IRS allows those age 50 and older to contribute additional “catch up” funds of up to $6,500. If you contributed less in your younger years, this is a great way fill the gap.

Do I keep my 401(k)?

Your 401(k) investment belongs to you. If you change jobs, your new employer may allow you to transfer those funds into the new plan. 401(k)s may also be rolled over into an Individual Retirement Account (IRA) which may allow more diverse investment options. You can also leave your money in your old employer’s plan or consolidate plans from former employers into a single IRA. Keep in mind, however, most employers have a period that workers must stay with the company to be vested and keep matched contributions.

If you withdraw money from your traditional 401(k) when you are younger than 59 ½ years old, you will trigger an early withdrawal penalty of 10%, and that money will be taxed as ordinary income.

How much should I contribute to my 401(k)?

Most experts recommend saving 10% to 15% of your income, but our suggestion is to get a more detailed goal from a retirement planning expert. How much money you’ll need in retirement depends on when you plan to retire, how much of your current income you’d like to replace and how much you want to rely on Social Security. Knowing these goals can guide your saving strategies. If you are unable to make the optimal contribution, you should at least aim to contribute the amount matched by your employer.

Another option available for people over the age of 59 ½, is an in-service rollover. An in-service rollover, or withdrawal, allows a person to transfer all or a portion of their 401k into an IRA outside the company without paying taxes. This option has been very popular over the years, especially when and individual is several years away from retirement and looking for safety of principal with no market losses, good growth and excellent monthly retirement income.

Do you have an old 401(k) that you want to roll over? Are you unsure if your current level of contribution will meet your retirement goals? We invite you to schedule a time to discuss your financial future and make sure you are on the right path. To schedule your no-obligation meeting, just click on the link below or call us today at 704-790-2583 (BLUE).