401(k)s have become one of the most popular retirement savings vehicles in America. But many people, including those who have been participating in a 401(k) plan for many years, aren’t clear about all the details when it comes to how their 401(k) plan works.
So here is a brief 401(k) primer that answers 6 of the most common questions many people have about their 401(k) plans.
1. How much money can I contribute to my 401(k) plan this year? In 2014, you can contribute up to $17,500 to your 401(k) plan, unless you’re 50 years of age or older. In this case, you can make a special catch-up contribution of $5,500, bringing your total maximum annual contribution up to $23,000 this year.
2. How soon can I start participating in my new employer’s 401(k) plan? This varies from one company to the next. Some companies allow employees to start participating in their 401(k) plan right away, while others require a short waiting period. Talk to your company’s HR department to find out what the requirements are.
3. What’s the difference between a traditional 401(k) plan and a Roth 401(k) plan? With a traditional 401(k), you defer paying taxes on the money you contribute until you withdraw it during retirement. With a Roth 401(k), you don’t get a tax deferral — your contributions are made on an after-tax basis. The tradeoff is that the money can be withdrawn income tax-free in retirement as long as the withdrawals occur after age 59½ and you have held the account for five years or longer.
4. What is an employer match and am I eligible for one? Many employers match part or all of the 401(k) contributions their employees make as an incentive to encourage workers to participate in and contribute to the plan. Matching formulas vary from one company to the next, but it’s not uncommon for employers to match 50 cents for each dollar employees contribute, up to six percent of their salary. Talk to your company’s HR department to find out if a match is offered.
5. What happens to my 401(k) account if I change jobs? You have several different options to choose from. You can cash out your 401(k), but if you do, you may be subject to a 10 percent early withdrawal penalty and the money could be taxed at your current ordinary income tax rate.
Or you can roll the balance over into your new employer’s 401(k) plan or an Individual Retirement Account (IRA). You can also just leave the money in the 401(k), though your employer might require that you cash it out or roll it over after a certain period of time.
6. Do I have to start withdrawing money from my 401(k) account at a certain age? You generally must start making required minimum distributions (or RMDs) from your 401(k) plan after you reach age 70½. But if you are still working after you turn 70½ and you aren’t at least a five percent owner of the company, you can defer distributions from your 401(k) account until April 1 of the year after you retire.
If you miss taking an RMD, you’ll be assessed a 50 percent penalty, so be careful not to make this mistake.
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. Member FINRA & SIPC