Everything You Need To Know About 401(k) Plans
Frequently Asked Questions
What are 401(k) plans?
401(k) plans are employer-sponsored retirement plans that some companies offer to employees. They are defined contribution plans that allow you to contribute up to a certain amount of money that is then invested in different funds.
How do 401(k) plans work?
With a 401(k), you select a certain amount of money that is transferred from your paycheck to your 401(k) account. Traditional 401(k)s use pre-tax dollars while Roth 401(k)s use after-tax dollars. The money in a 401(k) plan is invested and there are rules around contributions and withdrawals. Your employer may offer matching contributions and have a vesting schedule.
When were 401(k) plans established?
401(k) plans were established in 1978 via the Revenue Act, which included a provision to the Internal Revenue Code—Section 401(k)—that said employees did not have to pay taxes on deferred compensation. By 1979, many companies started offering employees 401(k) plans, and by 1981, the IRS recognized 401(k) plans as defined contribution plans.
How do 401(k) plans benefit employers?
Employers are rewarded for contributing to 401(k) plans with tax breaks that vary based on the plan type. The most common include being able to deduct the contributions the employer made from its federal income tax return up to a certain limit, and claiming a tax credit of up to $5,000 for up to three years to help offset the costs associated with starting the 401(k) plan.
How much can you contribute to your 401(k)?
You can contribute up to $19,500 per year to your traditional or safe harbor 401(k) plan as of 2021. For SIMPLE 401(k) plans, you can contribute up to $13,500 per year as of 2021. If you’re 50 years or older and your 401(k) plan permits it, you can also make catch-up contributions worth $6,500 to 401(k) plans and $3,000 to SIMPLE 401(k) plans as of 2021.
When can you withdraw from your 401(k)?
You can typically withdraw from your 401(k) at age 59 ½ if you’re no longer working for the employer who sponsors the plan. You can withdraw from your 401(k) without penalty via a loan, hardship withdrawal, or rollover to an IRA (if you leave the company) at any time. If you reach age 55 and also retire that year or later, you can withdraw from your 401(k). Required minimum distributions begin at 72.
What happens to your 401(k) when you quit?
After you quit a job, your 401(k) account will likely stay put where it is. You won’t be able to contribute to it anymore, but the money will still be invested, tax-deferred. If you have less than $5,000 in the plan though, your money may be sent to you or automatically rolled over into an IRA. You can also choose to roll over your 401(k) plan to an IRA or to a new 401(k) plan with a new employer.
A Roth 401(k) is an employer-sponsored retirement plan that allows for after-tax contributions. It combines the features of a Roth IRA and a traditional 401(k) to allow for tax-free distributions in retirement.
A 401(k) is an employer-sponsored retirement plan that allows employees to contribute a portion of their pre-tax earnings. Some employers match employee contributions up to a certain amount, thus increasing the compensation package for participating employees.
Safe Harbor 401(k)
A safe harbor 401(k) is a type of retirement plan that helps small business owners adhere to the Internal Revenue Service (IRS) test for non-discrimination. It's a way to structure a plan that passes the test or avoids it.
A 403(b) is a retirement account similar to a 401(k) but it is offered by non-profit organizations. Occasionally, a 403(b) and 401(k) are both offered by the same employer.
Qualified Retirement Plan
A qualified retirement plan is one that meets the Internal Revenue Code (IRC) requirements for tax benefits. They may be offered through your job; they often allow for pre-tax contributions and tax-deferred growth.
Self-Employed 401(k) Plan
A self-employed 401(k) plan is a retirement plan for small business owners who are the only employee (besides a spouse) of their business. The small business owner can make contributions for both employee and employer.
A 401(k) loan is when you borrow money from your retirement savings account. You’ll likely pay a fee to borrow and the loan will likely come with a term of one to five years. It could also cause you to be taxed twice on the money you borrow, and if you leave your job, you still have to pay it back.
Vesting refers to your portion of ownership in money or other assets that have been contributed by an employer to your retirement, stock-option, or another benefit plan. Examples of assets subject to vesting include employer-matching contributions or a share of the company's profits that amounts to a certain percentage of the employee's salary.
A profit-sharing plan is a type of defined contribution plan that allows companies to help their employees save for retirement. Employers use these plans to give their workers a stake in the company's success. It's also a benefit that can be used to attract new hires.
The Internal Revenue Service (IRS) offers retirement savers something known as a catch-up contribution. To qualify for catch-up contributions, you must be at least 50 before the end of the year. Catch-up contributions can be made in a traditional IRA, Roth IRA, SIMPLE IRA, SARSEP, 401(k), SIMPLE 401(k), 403(b), or 457(b) retirement plan.