401(k) retirement plans are frequent conversation topics, but are we aware of all they have to offer? If you already have an employer-sponsored retirement plan, you might not fully grasp how these plans work. The more we know about our 401(k) retirement plans the better. About 80 million workers contribute to their retirement plans, which has led to about $5.7 trillion in assets held for 401(k)s in the United States. 401(k) retirement plans do not have to be confusing for plan holders, especially with the many guiding resources which are easily accessible. We’re going to take it back to the basics, and ask, “What is a 401(k) retirement plan?”
How Did 401(k) Get Its Name?
The 1978 Revenue Act sparked the beginning of the 401(k). These retirement plans were named after a section of the Internal Revenue Code meant to give workers a tax-advantaged way to save for retirement. They are employer-sponsored, meaning employers provide their employees the option to contribute a percentage of their income to their plan. Employee-sponsored plans are defined-contribution plans, meaning they are typically tax-deferred. When an employee receives their paycheck, they’ll notice a portion of their earnings have been contributed, or invested, into their 401(k) before their income is taxed. An employee can be automatically enrolled in this option.. A young investor may opt in or opt out of contributing to a 401(k) plan. However, what a young employee may not understand investments accumulate over time and have a greater opportunity to compound for a larger nest egg the earlier they begin investing.
Let’s talk 401(k) Benefits
Tax Breaks – potential lowered taxable income for the year
Employer Match – some employers will match your contribution amount
High Contribution Limits – save more each year with a yearly limit of $19,500, or $26,000 after age 50
Contributions after 72 years old – contribute to your 401(k) as long as you’re still working and continue to have contributions at a pre-tax basis
Shelter from Creditors – 401(k)s are protected from creditors and IRS liens due to the fact these plans legally belong to your employer
What about 401(k) Withdrawals?
Any time you withdraw from your 401(k) you are taxed. The amount you are taxed depends on your income-tax rate when you take money out of your 401(k). There are restrictions as to when and how you can withdraw money from your retirement account. It is safe to withdraw after you have reached the age of 59½, however, withdrawing before this age could lead to a 10% early-withdrawal penalty fee in addition to any applicable taxes. By the time you reach the age of 72, it’s required that you take required minimum distributions (RMDs) from your retirement plan. If you’re still working at 72, it won’t be required of you to take RMDs from the plan provided by your current workplace, however, you will need to withdraw from 401(k)s from former employers.
How the 401(k) Won the Popularity Contest
If you combine the benefits and the savings opportunities, it is becoming clear how the 401(k) retirement plan option is a popular topic for investors, employers, and financial advisors. One of the extra takeaways advisors will point out is to not let your 401(k) plan roam free without maintenance. This is where allocation and rebalancing within your portfolio becomes very important. Review your plans performance as often as suggested and your retirement savings may see gains you wouldn’t be privy to without acknowledgement. Using tools such as The 401(k) Optimizer® could greatly benefit your retirement portfolio as it provides information about your contributions, their placements and recommends personalized allocations to help you meet your goals. If your employer offers a 401(k) retirement plan, it is never too late to sign up and begin saving for your future.