Features of 401(k)s
Everyone should know the basics about how their 401(k) works. But you probably won't pick up all the important facts in a one-hour 401(k) seminar. Here are the most important pieces of information you should know about your 401(k).
How much you can contribute
Workers can contribute up to $17,500 to a 401(k) in 2014, an amount that is adjusted annually for inflation. Employees age 50 and older can deposit an additional $5,500.
When to contribute
Some 401(k) plans allow you to sign up as soon as you start a new job, while others impose a waiting period of a few months or even a year before you can begin to contribute. Deposits to the account are typically made with money withheld from your paycheck.
How much you save in taxes
Traditional 401(k) accounts allow you to defer paying income tax on the funds you contribute until you withdraw the money. To find out how much you will save, multiply your contribution amount by your tax rate. You may also get a tax break at the state level. Low-income savers may additionally qualify for the saver's tax credit.
How to get a 401(k) match
Many employers will match part or all of the amount you contribute to a 401(k). Match formulas vary considerably by employer, but the most common 401(k) match is 50 cents for each dollar saved up to 6 percent of pay. Getting a 401(k) match is the quickest way to build up a large 401(k) balance.
When you become vested in the plan
While you always get to keep your contributions to the 401(k), you don't get to keep your 401(k) match or other employer contributions until you are vested in the plan. While some employers offer immediate vesting of employer contributions, other companies don't let you keep the entire 401(k) match until you have been with the company for as long as five or six years.
How to avoid the early withdrawal penalty
If you leave your job at age 55 or later, you can take 401(k) withdrawals from your most recent 401(k) without incurring the 10 percent early withdrawal penalty. However, if you leave a job with a 401(k) before age 55 or roll the money over to an individual retirement account, you'll have to wait until age 59½ to avoid the penalty.
How to add tax diversification with a Roth 401(k)
Roth 401(k)s allow you to prepay the income tax on your retirement savings, and then withdrawals in retirement will be tax-free. Roth accounts are a particularly good deal for young and low-income workers who expect to be in a higher tax bracket in retirement than they are in now.
What your 401(k) is costing you
Of course, 401(k) accounts aren't free. The Labor Department requires that data about the cost of each investment option be provided to individual 401(k) participants. Use this fee information to select the lowest-cost funds that meet your investment needs.
What to do when you change jobs
When you switch jobs, you have three options that will allow you to avoid paying income tax and the early withdrawal penalty: Leave the money in your old 401(k) plan, roll it over to an IRA or shift the balance to your new employer's 401(k) plan. Take a look at each option to see which has the best fund choices and lowest investment costs.
When to begin required minimum distributions
Typically, 401(k) withdrawals become required after age 70½. However, investors who continue to work after age 70½ (and don't own 5 percent or more of the company sponsoring the 401(k) plan) can defer distributions from their current 401(k) until April 1 of the year after they retire. The penalty for missing a required distribution is 50 percent of the amount that should have been withdrawn.
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