USA Today did a good story, with 18 frequently asked questions about 401(k) . I translated some parts, took two questions that didn’t make much sense, added some more comments and tables. They give a good idea of a great benefit that companies can give their employees. Although extensive, the content is not exhaustive and each case must be evaluated individually.
1. What is the difference between 401(k), 403(b) and 457 plans?
All three are variations of qualified retirement plans offered by US companies and are very similar. The main difference is who offers them. 401(k)s are typically offered by private for-profit companies and 403(b) are offered by non-profit or public employers. Meanwhile, 457 plans are generally offered by non-profit and public sector companies in addition to another retirement plan, such as a pension.
2. Can I use my 401(k) early?
You can access the money in your 401(k) whenever you want. However, if you use it before age 59.5 without a qualifying exception , you will have to pay a 10% IRS penalty. Common exceptions include if you are ordered by the court to surrender part of your 401(k) as part of a divorce settlement or to cover certain unreimbursed medical expenses. There’s also a separation of service rule that allows you to withdraw from your 401(k) without penalty from age 55 if you no longer work for the plan’s sponsoring employer.
3. What happens to my 401(k) if I leave my job?
You decide. Your main options may include:
- Leave the money in your former employer’s plan, where it will remain invested
- Transfer the money to your new company’s plan
- Transfer the money to an IRA
- withdraw it
Out of the last option, which is generally a bad idea, the others can be good options and you can compare them to determine the best choice for you.
4. What if I am ready to retire before I am 59.5 years old?
There are two main options that allow you to withdraw from the 401(k) before reaching the standard retirement age. As I mentioned earlier, if you are at least 55 years old and no longer work for the company, you can withdraw from your 401(k) without penalty. Or you can start withdrawals at any age if you agree to make a series of “substantially equal” periodic payments ( substantially equal periodic payments , SEPP). SEPP has some boring rules, so I suggest consulting your advisor if you want to use it.
5. What if I don’t need to use my 401(k) to pay my expenses?
If you don’t need your 401(k) money, you can’t just leave it there forever (unless it’s a Roth 401(k)). From the year you turn 70.5, you will have to start making required minimum distributions (RMDs) based on your age and account balance.
6. What is the contribution limit for my 401(k)?
The 2018 contribution limit for elective deferrals ( deferrals elective ) is USD 18,500. This does not include any matching contribution made by your company, any mandatory contributions or any confiscation allocations ( forfeitures ). If you are 50 or older, you can contribute an additional USD 6,000 for 2018 as a “catch-up” contribution.
7. What is a Roth 401(k)?
The biggest difference is the tax treatment. 401(k) contributions are deducted before tax (therefore, they reduce your taxable income) in the year they are made, but withdrawals will count as taxable income (in other words, the tax is deferred to the future when the withdrawals are made). Roth 401(k) contributions, however, are made after tax , but qualifying retirement withdrawals will be 100% tax free (tax is paid today).
8. What is a 401(k) loan?
Many 401(k) plans offer participants the ability to borrow money from their accounts. If allowed, these loans can be up to USD 50,000 or half the account value, whichever is less. Participants typically have to pay the loan back, with interest, over a period of up to five years (there are longer terms for primary home purchases available).
9. Is a 401(k) loan a good idea?
In most cases, no . Even though you pay yourself back with interest, your money will pay off more in the long run if you simply leave it invested (long live compound interest!). However, they make sense in some cases. For example, if used to consolidate high interest credit card debt.
10. How should I allocate my 401(k)?
The original answer to this question was the worst possible:
As a general rule of thumb, I suggest subtracting your age from 110 to determine how much of your 401(k) must be in stocks. The remainder must be in fixed income. Thus, a 40-year-old should have about 70% stocks and 30% bonds. Check out our asset allocation guide for more details on how to invest your 401(k).
The correct answer should be: it depends . People of the same age have different goals and situations . In addition, you must take into account ALL the accounts you have and use them to maximize the return on your portfolio. For example, as a 401(k) is tax-deferred (ie you only pay income tax on withdrawals when you retire) investments that yield more over time (such as stocks) should be allocated to it.
11. What do I have to do to get a tax break for my 401(k)?
Usually nothing. The money you choose to withhold from your pay and deposit into your 401(k) is generally subtracted from your federal wages in your W-2 each year. If you are a business owner or have a 401(k) solo, you will need to track your deposits and claim them on your tax return.
12. How much tax will I pay when I withdraw from my 401(k)?
If you own a Roth 401(k), you won’t pay a penny in taxes – unless you withdraw your investment returns in advance.
In a standard 401(k), your withdrawals are taxed as ordinary income. The tax rate will depend on which tax bracket you are in. And if you withdraw from your 401(k) early without a valid reason as defined by the IRS, you will pay an additional 10%.
13. What if I inherit 401(k) from someone else?
If you inherit your spouse’s 401(k), you can essentially treat it as your own. Standard Minimum Withdrawal and Withdrawal (RMD) rules apply.
If you inherit a 401(k) from someone other than your spouse, you usually have the option to withdraw all the money at once (beware of taxes), either over a five-year period or on annual distributions based in your life expectancy.
14. Can I contribute to an IRA and a 401(k)?
It depends on your income. Traditional IRA contributions are allowed for everyone, regardless of income, but the tax deduction has income limitations if you have a retirement plan at work.
If you participate in your company’s retirement plan, the income limits for you to be able to deduct the contribution to your IRA are as follows:
So if your statement is Married Filing Jointly type, you can deduct your total IRA contribution if your income is up to $101,000. Above $121k it is not possible to have a deduction.
If you do not participate in your company’s retirement plan, the limit only exists if your spouse participates in their company’s retirement plan.
Roth IRAs have income limits that apply to everyone, whether or not they have a retirement plan.
15. What percentage of my salary should I contribute?
This will depend on your retirement plans. At the very least, you should contribute enough to make the most of your company’s correspondence program. In other words, if she matches your contributions up to 5% of your salary, 5% of your salary is the minimum you should contribute.
16. How do matching contributions work?
The most common way is for a company to contribute what you save, up to a maximum percentage of your salary. For example, a matching threshold might look something like “50% of your contributions, limited to 6% of your salary”. This means that if you contribute 6% of your salary to your 401(k), your employer will put 50% of that amount (3% of salary), for a total savings rate equal to 9% of your salary.