Saving for retirement crosses everyone’s mind at some point in their life, and the first question you ask yourself typically is, “where do I start?” One of the most common ways to start savings is by starting a 401(k) plan with your employer!
A 401(k) is a type of retirement plan that is directly tied to your employer. Employees can contribute a portion of pre-taxed income where it can grow tax-deferred until the time you withdraw your savings. Many companies will offer a match-incentive to their workers as well. There are many other benefits to leverage from a 401(k), but it’s important to know what are the other retirement plans available to you – let’s take a look.
Common Retirement Plans
When it comes to retirement plans, it’s crucial to understand the benefits, as well as the rules of each. For instance, if an individual has a 2020 MAGI (Modified Adjusted Gross Income) of over $139,000, they will not be able to reap the benefits of a Roth IRA (Individual Retirement Account) – Roth IRAs are only available to those that have a 2020 MAGI below $139,000.
The two main items to look out for in a retirement plan are the rules around putting money in, or contribution limits, and how taking money out works, or withdrawal rules.
How Do 401k Plans Work?
Let’s review how these employer sponsored retirement vehicles work. What are the different types, where to get them, contribution limits and more.
Are There Different Types of 401(k) Plans?
Yes, there are Traditional and Roth 401(k) plans. Your employer will be able to tell you which they offer, if not both.
Where Can I Get a 401(k) Plan?
All 401(k) plans are employer-sponsored retirement plans. You may have information about this in your employee benefits package, but you can always contact the human resources department to learn more about what your company offers.
How Much Money Can I Put Into My 401(k) Plan?
Both types of 401(k) plans have a $19,500 annual contribution limit for 2020. These limits are never set in stone – this year’s contribution limit has grown from 2019’s which was $19,000.
The IRS also offers individuals over the age of 50 a “catch-up” option. This means they can contribute an additional $6,500 to their 401(k) for a total contribution limit of $26,000.
When Can I Access Money in My 401(k)?
The IRS penalizes you for taking money out too earlier. Because of that, they have created various triggers that allow an individual to take money out of their 401(k) plan penalty-free:
- The individual turns 59 ½
- The individual has retired
- Or the individual passes away or has become disabled
The IRS created Required Minimum Distributions (RMDs) rules if none of those events occur. The required date to begin RMDs is on April 1, of the following year you either reach age 72, or retire (per your plan’s rules).
What Happens to My 401(k) If I Change Jobs?
Just because the account is held with your employer, doesn’t mean it has to stay with them if you leave – so what should you do with your 401(k) plan? There are a few options to choose from and none of them include you losing your money:
- Leave it with your former employer
- Roll-over your 401(k) savings into an IRA
- Transfer the plan to your new employer
- Withdrawal your funds or “cash out”
What Are 401(k) Plans Benefits?
Here we shall review what the benefits are for both a traditional and a Roth 401k.
Traditional 401(k)
Contributions to traditional 401(k) plans are pre tax, which means you can reduce your annual MAGI, or in other words, you’re able to deduct your contributions from your tax bill. You will have to pay taxes on the savings, but not until you begin withdrawing funds.
Another benefit is an employer match program – where your employer matches your contribution entirely, or a percentage of your pre-tax income, to your plan to help meet the annual contribution limit.
If your employer offers a match incentive program, and you are not taking advantage of it, you are saying no to money today, and the potential compounded returns, which can add up over time.
Roth 401(k)
Contributions are taxed when you’re putting money in, which means your money can be grown tax-free until you withdraw your savings. Similar to traditional 401(k) plans, employers can also offer a match incentive for contributing to the retirement plan.
401k vs IRA Plans
Individuals can have both a 401(k) and IRA plan, but depending on the filing status and MAGI. You may not be able to utilize both plans’ tax-advantage.
The major difference between the two are the contribution amounts – $19,500 for 401(k) plans and $6,000 for IRAs – and who offers the plan – 401(k) plans are employer-sponsored and IRAs can be started on your own.
Since 401(k) plans are employer sponsored, investment options may be limited and rather expensive, and can be rather inflexible. Thinking glass half full, if your employer has match offerings, not taking advantage of that is essentially saying no to free money. The opposite goes for IRA accounts. You can choose from the entire public stock, mutual fund or ETF universe for your portfolio but there are no match options available.
How To Choose a Retirement Plan
Picking a retirement plan is not straightforward. To know which plan offers the most advantage to your financial journey, it requires you to understand how each work. Also you need to know where and how they fit into your situation – if at all.
If this guide did not answer your questions, you’re not alone. We know how hard it can be to get your financial goals and savings nests in order. That’s why Investment Firms created the financial advisor matching tool to connect you with registered advisors in your area. They are a call away to help you answer your questions, and prepare you for retirement.