There are many types of retirement plans and strategies to consider. One of most common types of retirement funds used by United States employees is the 401 (k). It is intended to help employees prepare for retirement by contributing a usually small amount of their income to an investment fund. Many of these plans also have some degree of matching funds coming from the employer.
Of course, not all 401 (k) plans are the same. Some have different features, and stipulations. Understanding some of the more common questions associated with 401 (k) plans can help you make the most out of your short and long-term investments.
1: Will I be able to use my money before retirement?
This is a somewhat complicated question. Most of the common exemptions come with the early-withdrawal penalties. This typically includes things like first-time home purchases as well as college expenses, and they only apply to money that is first rolled over into an IRA.
Yet there are a few special exceptions where you might be able to access a small portion of your account early. One possible option is for withdrawing money for medical expenses, so long as those expenses exceed 10% of your adjusted gross income. Another possible allowance is if you become permanently disabled, then you can directly withdraw from your 401 (k) account without any penalty fees.
It’s also worth bearing in mind that there are some 401 (k) accounts that have provisions that allow you to borrow against a certain portion of your account. However, this is not necessarily true of all 401 (k) accounts. So, you should do your research before you even consider this as a viable option to get the funds you need.
2: What If I Retire Early?
401 (k)s are generally set up so that you can’t access the funds until you are 59 ½ years of age. However, there are a few special circumstances that may allow you to withdraw from your 401 (k) without having to pay significant penalty fees.
The first scenario is known as the Separation From Service Rule which states that if you stop working for your employer after your 55th birthday, you can withdraw from your 401 (k). This provision is applicable if you quit your job, you are fired, or retire from the job.
The second scenario which is known as Substantially Equal Periodic Payments, or SEPP, is a little bit more complicated. In this situation the IRS allows you to withdraw funds of substantially equal payments that are based on your life expectancy, which is assessed by the IRS established life expectancy tables.
There are other stipulations with a SEPP. Namely, you cannot be working for the employer who provided or contributed to your 401 (k). You must also continue those distributions for five years or until you reach 59 ½ years of age.
3: How Much Can I Contribute To My 401(k)?
The Internal Revenue Service sets an elective deferral limit for 401(k)s at $18,000, in a given year. If you are over 50 years of age you can contribute an additional $6,000 in catch-up contributions. You also have to bear in mind that this only applies to money you choose to have withheld from your paycheck. This number does not include a matching contribution from your employer or other sources. When you factor in other possible contribution sources the maximum is $54,000 for people under 50-years old and up to $60,000 if you are older.
4: What Is The Right Amount To Contribute To A 401 (k)?
Just how much you want to contribute to your 401 (k) can vary widely depending on your specific goals, your age, and your financial situation. There is no simple answer to this question. However, it is best to at least contribute enough to fully qualify for your employer’s matching program. Any less than that is missing out on an important opportunity.
There are various ways to calculate how much you might need for retirement, and how you can factor that into your overall retirement plan. Most 401 (k) programs have a calculator system built into them. If the amount it calculates is less than what your expected retirement income will be, you should strongly consider increasing the amount you contribute with each paycheck.
5: What Does It Mean To Be Fully Vested In Your 401 (k)
Each 401 (k) program comes with its own set of stipulations, that are influenced by the employer, as well as other factors. To become fully vested in your 401 (k) you must contribute to it for a specified amount of time. As time goes on you will own more and more of your 401 (k) based on a time calculated percentage.
For example, let’s say you start a job that offers a 401 (k) program, your employer matches a specified amount. At that point, you would likely have 0% vested in your employer’s contribution. If you were to leave that job a few months later, you would not be able to keep any of the money your employer contributed.
As the years go by your vested percentage will increase, and you will be able to retain more of your employer’s contribution. At a certain point, that amount will reach 100% and you will be considered “Fully Vested.” If you were to leave the job at that point you would be able to retain 100% of the value of your 401 (k).
6: Is It Possible To Borrow Money From A 401(k)?
Some but not all 401 (k) plans allow you to borrow from them. This depends on how your employer sets it up. Most of the programs that do allow you to borrow from it require you to pay the money back with interest. They also only allow borrowing up to a specific amount, which is usually set at $50,000 or up to half the balance of your 401 (k) amount, whichever amount is less.
However, this isn’t an option you should consider lightly. Taking any money from your 401 (k) can significantly reduce its compound growth. It’s also worth noting that there are large penalty fees if you can’t repay the borrowed amount on time.
7: What Should I Do With A 401(k) From A Previous Employer?
When you change jobs or become separated from the employer who provided you with a 401 (k) you do still have some options. Technically, you can park the 401 (k) or simply leave it where it is, so long as the total value of the 401 (k) meets a certain minimum threshold, which is usually set at $5,000.
If you prefer, you can “Roll It Over” into an IRA. Some employers will even allow you to simply roll it into your new employer’s plan.
Some 401 (k) programs do allow you to cash them out. However, the tax penalties and fees are often stiff and intended to be prohibitive. You will definitely want to read the fine print on your plan before you even consider this option.
8: How Should I Allocate Or Invest Through My 401(k)?
This is a very complicated question and will vary depending on your age, your goals, the rest of your investment portfolio and much more. Different programs may allow you to set up different investment strategies. This essentially means you can set up a vague percentage of how much of your 401 (k) is allocated to things like stock, bonds, and other investment options. Some even allow you to control a portion of your 401 (k) through a brokerage account.
Unless you are already an experienced and savvy investor a brokerage account may be a risky option. Most 401 (k) plans come with some sort of primer or tutorial on asset allocation, which you can use as a guide when setting up your 401 (k),
9: Is It Possible to Contribute To An IRA As Well As A 401(k)?
Technically, you can indeed contribute to both an IRA and a 401(k) at the same time. However, your income will directly determine whether it’s possible to take a tax deduction for traditional IRA contributions or contributions that go directly into a Roth IRA.
Let’s say you are single and have a 401(k) through your employer, then it’s only possible to deduct all of your traditional IRA contributions if your adjusted gross income is less than $62,000 a year.
10: Is It Possible To Get A Tax Break For My 401(k) Contributions?
The IRS excludes 401 (k) contributions from your federally taxable income. However, they do not your income for Social Security or Medicare based on your payroll taxes. It’s also worth keeping in mind that you do not need to itemize your deductions on your tax return to take advantage of this tax break. The annual W-2 you get from your employer will be automatically subtracted from the income you will need to report to the IRS.