401K: Benefits of Having a 401K
While different types of retirement accounts are available, 401k plans are the most popular options since many employers offer them as part of their benefits package. Employees can sign up for 401k plans to take advantage of the tax benefits while saving for retirement. In many cases, employers match employees’ contributions.
Making contributions to a 401k plan is simple once employees sign up. However, laws and regulations set 401k plan limits to prevent individuals from contributing more than a certain amount. Similarly, regulations impose penalties when individuals withdrawal funds earlier than a certain age.
Types of 401k Plans:The federal government taxes traditional and Roth 401k plans differently. Contributions to traditional 401ks come directly from the employee’s income and reduce the total income he or she must pay tax on. For example, if a worker contributes $5,000 of his $45,000 annual salary, then his income is $40,000 for tax purposes. However, when he withdraws funds later, he will pay the taxes for the withdrawn sum.
Roth 401k contributions are post-tax funds and, therefore, withdrawals are tax-free since the employee has already paid the taxes. For instance, a worker pays all of his income taxes regardless of how much he contributed to his 401k but can withdraw funds without paying a tax penalty.
How to Set Up 401k Contributions
Employers partner with broker providers to set up 401k accounts for their employees. Usually, during orientation, a representative from the employer’s human resource department or the broker provider will review options with new employees. Workers will need to establish how much to contribute, review employer-matching incentives and select investments.
Workers can sign up with the provider and choose which investments they wish to fund. 401k plans can include:
- Stocks and bonds
- Mutual funds
- Target-date funds
- Exchange traded funds
- Guaranteed investment contracts
- The employer’s stock
Some investments are riskier than others, and workers can discuss the pros and cons of each type with the provider. Additionally, employees can modify their investment portfolio. Many individuals choose less risky investments as they near retirement age.
As workers switch jobs and companies, they can also transfer their 401k contributions. While a 401k withdrawal on certain plans can result in a tax penalty, rolling funds into a new employer’s plan will not.
National 401k Broker Providers:Many providers have 401k plans for business owners. Employers may choose a 401k provider based on fees or services. Some of the most popular providers include the following:
- Wells Fargo has a diversity of 401k plans and provides full-scale administrative services. In addition, the company has payroll and cash management services
- Merrill Edge also has several plans to choose from and is a lower-cost option
- Fidelity 401k accounts are full-service and employers and employees can take advantage of independent and in-house investment options
- Vanguard is the biggest company in the world for mutual funds and does not offer services to small businesses
For instance, a company may select Fidelity 401k accounts since the provider offers many services, such as plan administration, reporting and record-keeping. Fees for administrative costs can cost a low percentage (typically less than 2percent) of the total assets.
401k Plan Limits for Contributions:Almost every year, the Internal Revenue Service (IRS) adjusts the maximum contribution limit. As of 2019, the annual 401k plan limits are $19,000 for workers younger than 50 years of age and $25,000 for those 50 years of age or older.
The IRS also caps employer contributions. The total 401k plan limits for employees younger than 50 is the lesser of $56,000 or the worker’s salary, as an employee and employer cannot make contributions totaling more than the worker’s earnings. The cap for workers 50 years of age or older is $62,000.
Making a 401k Withdrawal:Depending on the type of 401k plan the worker has, he or she may need to pay taxes when withdrawing. Individuals who make a 401k withdrawal before 59-and-a-half years of age will need to pay a 10 percent penalty. However, the IRS may waive early-withdrawal penalties in different situations.
For example, individuals may make a 401k withdrawal without incurring a fee if they need funds during hardship, such as to pay for medical expenses, housing repair costs or funeral expenses. Additionally, individuals may withdraw 401k funds to pay for tuition or as a down payment for their primary residence.
After 59-and-a-half years of age, workers may make a one-time lump sum 401k withdrawal or make multiple withdrawals as needed. Individuals may leave funds in the account until 70-and-a-half years of age when the IRS requires initial distribution of funds.