What Is a 401(k) Plan and How to Save for Retirement

Many employers offer a 401(k) retirement savings and investment plan as part of employee benefits. Employees should take advantage of plan offerings to prepare for a financially fruitful retirement. Keeping income, employer match and legal requirements in mind will help employees retire with confidence.

About 31% of employees say they don’t understand their employee benefits, including the retirement savings options offered by their company. One of the most common retirement savings plans is a 401(k), and if you’re not investing in it early, you’ll miss out on long-term wealth.

A 401(k) plan is an American retirement savings plan named after a U.S. Internal Revenue Code section. Employees that sign up for 401(k) plans allow a portion of their paycheck to deposit tax-free directly into this investment account each pay period.?

401(k)How Do You Get a 401(k)?

A 401(k) is an employer-sponsored retirement savings plan that you can’t obtain elsewhere. If your employer offers 401(k) plans, you’ll likely need to sign up within a specific time frame after their start date.?

Your employer is also in charge of setting up the plan’s terms. According to corporate recruiter Tejal Wagadia, most new employees will hear during their offer that “benefit costs and 401(k) match are 99% of the time non-negotiable.” In other words, you’ll know what your employer offers in terms of employee benefits before you even get started to make an educated decision about your financial future.

Traditional 401(k) Plans vs. Roth 401(k) Plans

Although the names are similar, a traditional 401(k) and a Roth 401(k) have unique differences. Choosing the right plan comes down to paying taxes.?

You get a tax break up front with a traditional 401(k). You pay into it with pre-taxed funds from your income, making the amount you pay in income tax much lower. This money is also tax-deferred until you withdraw it. However, this counts as “income” and gets taxed based on the current tax rate when you withdraw the funds.

When you contribute to a Roth 401(k), your contributions have had taxes withdrawn already. You won’t have to pay taxes again when you make withdrawals after age 59? if you’ve had the account for at least five years.?

Traditional 401(k) Plan Benefits

Employers commonly offer a traditional 401(k). Some key benefits of this type of retirement plan include:

• Taxable income is lower for each year you make contributions. The money you put into a traditional 401(k) isn’t taxed before it gets deposited, so you don’t have to pay taxes on this income until you withdraw from the account during retirement.?
• Your employer can make matching contributions. Employers may choose to contribute a percentage of the amount you contribute to your plan. This is an easy way to build wealth faster.?
• You can continue to contribute after age 72. Some retirement accounts require you to stop contributing (even if you’re still working) when you turn 72; 401(k)s don’t have this requirement, and you can keep contributing without having to make withdrawals for as long as you work.

Roth 401(k) Plan Benefits

Your employer may offer a Roth 401(k) plan instead of a traditional plan. Keep in mind that there are benefits to choosing this plan as well, including:

• There is no income limit. A Roth 401(k) is an excellent option for high earners that want to invest in retirement without having to convert funds into a traditional IRA.?
• Your employer can match your contributions. Similar to a traditional 401(k), you can obtain extra funds in your account if your employer offers to match your contributions.
• Qualified withdrawals won’t get taxed. Your contributions get taxed before they reach your account. This way, you won’t have to worry about these taxes when it comes time to use your retirement funds.?

How Does a 401(k) Help You Save for Retirement?

Investing in a 401(k) through your employer makes retirement planning easier.?

You don’t have to think about putting money into the account each month. The payroll department at your company transfers part of your paycheck directly to your retirement savings. Plus, you may get paid to save if your employer matches your contributions, leading to more funds for your retirement.?

A traditional 401(k) plan that doesn’t have great rates or match percentages is beneficial for long-term growth.

Tips for Maximizing Your 401(k)

To get the most out of your 401(k), you should:

• Contribute at least enough to maximize your employer match.
• Monitor your portfolio and rebalance as necessary.
• Diversify your retirement portfolio investments whenever possible.
• Avoid retirement funds that have high fees.
• Consider how much risk you can afford when setting up your account.

Talk with the experts that control your retirement fund to get additional advice and guidance on building wealth in your retirement portfolio if you want hands-on experience.?

Otherwise, the plan sponsor experts or a robo-advisor choose where to invest your funds on your behalf. Mutual funds, bond funds, index funds and other similar types of funds are all common options for this type of investment. The market, your financial goals and your account settings are all considered during this process.

Important Factors to Remember With 401(k) Plans

The main rules that you need to know regarding traditional 401(k)s or Roth 401(k)s relate to contributions, withdrawals, and changing plan sponsors.?

You must keep in mind the following when you choose to set up a 401(k):

• How much you can contribute
• When you can withdraw penalty-free
• How to calculate minimum distributions
• What to do if you change jobs

Making Contributions to Your 401(k)

Both 401(k) plans have contribution limits that change each year. For 2022, the contribution limit for individuals under age 50 is $20,500. If you’re over 50, you can contribute up to $27,000 in 2022.

You’ll have to remove the excess funds if you contribute too much in a year. You’ll also pay a 10% penalty for early withdrawals.

Required Minimum Distributions

Required minimum distributions (RMDs) are minimum amounts that plan owners must withdraw every year starting with the year they retire or reach age 72.?

Getting a New Job

When considering the employee benefits at a new job, keep in mind that you can take your 401(k) with you. You’ll have to transfer your old 401(k) money into an account created through your new company’s plan.?

To roll over your 401(k) funds, follow these steps:

1. Open an account at your new company.
2. Contact your previous 401(k) provider.
3. Request that funds get transferred directly to the new account.
4. Close the old account with your former employer.?

You can transfer those funds into an individual retirement account (IRA) to continue investing in your retirement if your new workplace doesn’t offer a 401(k).?

Understanding the Importance of a 401(k) Plan

Investing in a 401(k) as part of your employee benefits is the smart and responsible action. When it’s time to retire, you’re going to thank your past self for putting in the effort.

If you’re ready to start investing today, take the following steps:

1. Talk to your HR department about your retirement options.
2. Figure out what percentage of your income could go toward retirement funds.
3. Sign up for an account through your employer.

(Reporting by NPD)