401(k) Questions and Answers
If you're new to 401(k)s, you may have some questions about how this retirement plan works. Fortunately, you can find the answers, even if some of the details may vary from company to company or plan to plan. Make sure you check in with your plan administrator to find out the specifics of your particular 401(k) plan.
If you are "vested" in your 401(k), it means that you have ownership of the contributions from your employer to your account. The vested amount is the amount that you take with you if you were to leave your job. While your own contributions are always 100% vested, you may not be vested in your employer's contributions until a certain point in time.
There are a variety of vesting schedules your company may follow. You may be vested immediately, or after working there for three years, or perhaps there is a gradual increase each year. Your employer can tell you about their vesting schedule.
The reason companies set up 401(k)s in this manner is because they want the workers they hire and train to stay with them. If you haven't been with your company long, you may not yet be vested in your account, and they hope that's an incentive to stay with the company until you are.
To begin with, it is important to take advantage of any match that your employer offers you. For example, if they say they'll match your contributions up to 5%, then make sure you're contributing 5% because your employer will contribute another 5%. It's like you're contributing 10% of your income for half the cost.
Your employer match will help your retirement account to grow. However, you may wonder if you can contribute above and beyond that match. The answer is yes—up to $19,500, with catch-up contributions of $6,500 allowed if you're over 50.
If you have the money to spare, you also may also want to open and contribute to an individual retirement account, also called an individual retirement arrangement (IRA).
The difference between a Roth 401(k) and a traditional 401(k) is when you are taxed.
With a traditional 401(k), your contributions reduce your taxable income now, and you pay taxes on them later, when you make withdrawals during retirement. In other words, it's tax-deferred.
With a Roth 401(k), on the other hand, you contribute after-tax dollars, but then your income earned in this account is tax-free.
When you change jobs, you don't have to leave your 401(k) behind. What you can do is "roll it over" into another account—typically into another retirement plan or an IRA. That way, your contributions (and any vested employer match) will go with you when you leave. It's important to complete the rollover within 60 days; if you don't roll it over, it will be taxable.
If you have between $1,000 and $5,000 in your 401(k), and you don't choose to roll it over or receive the money, your former employer may deposit the money into an IRA for you. If you have less than $1,000, they may just cut you a check and withhold 20% for taxes. However, you can still roll over the distribution within 60 days.
It is always good to understand the funds in which your money is invested. You should at least understand the basic types of mutual funds and the risks associated with them. It will help you to make choices that you are comfortable with when you choose where to invest your money. You should also know that mutual funds do come with certain risks, including the risk that you may lose money.
Your plan may also offer the option to invest in stocks, bonds, or annuities. Each has pros and cons, and your best decision will depend on how long you have to invest and what your goals are.
If you have questions, ask your plan sponsor or human resources representative to give you an overview. Also, be sure to review your 401(k) statements regularly to understand how your investments are doing.
A 401(k) loan allows you to borrow money from your 401(k) account. However, you should be cautious before resorting to a 401(k) loan. For one thing, you must pay it back within five years, plus there are limits on what you can borrow.
If you were to lose your job or get laid off, the balance is due in full—right when you might have trouble making ends meet. Otherwise you will be expected to pay the taxes and penalties as though you had taken a disbursement.
Borrowing from your 401(k) should be a last resort.
If you don't qualify for a 401(k) right now, you can (and should) still save for retirement.
One way is to contribute to a Roth IRA or a traditional IRA. Plus, there are also other retirement options available if you are self-employed, such as a Simplified Employee Pension (SEP-IRA), solo 401(k), Savings Incentive Match Plan for Employees (SIMPLE IRA), Keogh account, or taxable investment accounts. You can start saving now even with a small initial investment.