401 (k) Basics: A Getting Started Guide to Understanding Your Retirement Plan

AAlthough they may seem similar at first glance, your 401 (k) is very different from a traditional savings account. Between the rules dictating how much money can be contributed to the plan and the differences between a Roth account and a traditional retirement plan account, understanding your 401 (k) plan can be confusing at times. Below is a brief question-and-answer session on some of the most common inquiries we receive from participants like you.

What are the differences between a traditional Roth 401 (k) and a Roth?

The main distinction is the tax benefit.

  • Traditional 401 (k) contributions are made on a pre-tax basis and individuals pay income tax on amounts withdrawn upon retirement.
  • A Roth 401 (k) function allows the contribution of after-tax dollars. The amount chosen is deducted from your salary after income, social security and other applicable taxes are withheld.

How is money deposited into my 401 (k) plan?

Once you have met your plan’s eligibility rules, money flows into your account in two main ways:

  • Via your paycheck.
    • Once you have selected the amount you wish to contribute to your 401 (k) account, that percentage or dollar amount is deducted from your paycheck. Contributions are established through your employer’s payroll system and are deducted from each paycheck during the pay period.
  • Via your employer’s contributions.
    • Some plans have what’s called an “employer match,” which means the employer will contribute to your account based on the amount you contribute, up to certain limits set by the IRS or your plan document. For example, if your plan has a match of up to 4% and you contribute 3%, your employer also contributes 3%. If you contribute 5%, your employer will contribute 4%.

What are the contribution limits for a 401 (k)?

It depends.

  • For 2022, the annual 401 (k) contribution limit is $ 20,500 (indexed annually for inflation), whether the funds are a pre-tax or Roth contribution (up from $ 19,500 in 2021). However, participants aged 50 or over can contribute up to $ 27,000 per year.
  • $ 20,500 is the limit that you can contribute from your own paycheck. If your plan offers a match with the employer, the amount of your employer’s contribution is added to your own contribution.

How much should I contribute to my 401 (k)?

It differs depending on your personal financial situation.

  • This is a decision that only you should make based on your other investments, your tolerance for risk, how much income you think you will need in retirement, and many other factors.
  • There are several tools that can help you. Consider using a 401 (k) calculator by selecting one of the many options available online.
  • The most important thing you can do is start saving now. The impact of growth over time can have a huge impact on your accumulated savings due to compound interest, dividends, capital gains, and investment returns. For example, Mary saves $ 250 / month from age 28 and Marco saves $ 250 / month from age 35. * Assuming a tax-deferred annual rate of return of 7.00% compounded monthly, Mary and Marco take they retire at age 67 and the difference in their savings is $ 254,000 ** despite a difference of only $ 21,000 in total 401 (k) contributions.

* This hypothetical scenario is provided for guidance only and is not intended to represent the performance of any specific investment. Past performance does not represent future results. Actual returns will vary and principal will vary. Taxes are due on traditional contributions upon withdrawal. The performance of any investment is never guaranteed.

** Assumes a growth rate of 7%, compounded monthly with each monthly payment made at the start of the period. Numbers have been rounded to the nearest thousand.

What is a rolling contribution?

Funds from your retirement plan account with a previous employer or an Individual Retirement Account (IRA).

  • A rollover contribution refers to funds that you transferred from your former employer’s retirement account or another qualifying plan to your new employer’s retirement account. If your plan accepts working capital, you can consolidate your retirement accounts by transferring assets from those other accounts. For example, if you previously had funds in a retirement account with ABC Retirement and started a new job with an employer who has an account with XYZ Retirement, the movement of those funds from the previous provider to the current provider is called the “rollover contribution”.

What are the different ways to withdraw funds from my 401 (k) account?

There are several ways to withdraw money from your account depending on the features offered by your plan.

  • First of all, know the basics.
    • Your 401 (k) is intended for use after retirement age. To discourage early withdrawal of funds from the pension plan, withdrawals before age 59 and a half are subject to withholding taxes and early withdrawal penalties. Participants are also required to start making withdrawals when they reach age 72, known as Minimum Required Distributions (“RMD”).
  • Via the minimum required distributions (RMD).
    • RMDs are the minimum amount you must withdraw from a pension plan each year after reaching age 72. However, as indicated on the IRS website, Roth IRAs “do not require any withdrawal until the owner dies.” *
    • * There are exceptions to this rule for participants who own a certain percentage of the business.
  • Via distribution of difficulties.
    • Participants may be able to withdraw funds if they can demonstrate significant financial need. The IRS allows withdrawals for certain types of “significant financial need,” but generally, this type of withdrawal is intended to cover medical bills, funeral expenses, and similar emergencies. Unlike a loan, a hardship withdrawal does not need to be repaid.
  • Via loans.
    • A 401 (k) loan is a way to borrow against your retirement account while agreeing to repay the balance, plus interest, within a specified time frame. Loans typically have a term of 1 to 5 years, although your plan may allow for a longer term if you are using the loan to purchase a primary residence. Your loan must be paid off through payroll deductions or paid off in full by a lump sum payment.
    • Participants can take out a “loan” from the acquired balance of their plan. The IRS limits the loan amount to the greater of $ 50,000 or 50% of the participant’s acquired account balance. There may be restrictions in the plan, such as the number of loans a single participant can have outstanding or the number of loans a plan can have at any one time for all participants.

For more information on 401 (k) pension plans and other workplace savings plans, visit vestwell.com

This article originally appeared on Vestwell.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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