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What is a 401(k) Plan?

When can I withdraw from my 401(k)?

When it comes time to withdraw your money in retirement, traditional 401(k) plans have certain distribution requirements, which typically begin the year you turn 70½. Because Roth 401(k) contributions are made with after-tax dollars, the withdrawals are not subject to the same required minimum distributions.

Aside from tax implications and early-withdrawal penalties, there are other considerations — such as where to invest — when choosing a withdrawal strategy for your 401(k) plan:

  • Many people take all of their money out of their 401(k) plan when they retire and roll it into an IRA, so they can manage it on their own or with an advisor. However, it may be beneficial to remain at least partially invested in the plan.
  • Many plans actually want you to stay invested in the plan, as they can negotiate lower fees with vendors when they have more assets. These lower fees may make it advantageous to stay in the plan versus selecting investment options outside à la carte.
  • In addition, if your 401(k) plan is invested in a target date fund, it may offer an investment mix that's designed to help meet the needs of people in retirement.

Who is eligible for a 401(k)?

The basic qualifications for being eligible for a 401(k) are:

  • You must be 21 years of age
  • You must be a full-time employee, who has served up to a year of service

If you meet this criteria, your employer must allow you to participate in a company-matching qualified retirement plan. Not all employers make employees wait a full year before enrolling (the longest allowable time by law). However, it is not uncommon to experience up to a six month waiting period from the time you join a company – or longer – to start building up your retirement savings. As this is a very important topic to many, it’s wise to ask a prospective employer about their retirement plan if you are considering an offer of employment.

Which 401(k) is best?

Two common kinds of 401(k)s are traditional and Roth 401(k) plans. In many ways, these two types of retirement savings plans are similar. Unlike traditional or Roth IRAs, 401(k)s don’t have an income limit to participate. Both are subject to the same annual contribution limit, which is much higher than the contribution limits placed on IRAs.

To boost your contributions even further, you might consider catch-up contributions. If you are 50 years of age or older and have an eligible 401(k) plan, you can make 401(k) catch-up contributions, which allow you to contribute more than the annual contribution limit to your retirement plan. While they can help turbo-charge your savings as you near the retirement finish line, you don’t actually have to “be behind” in your retirement savings to take advantage of catch-up contributions.

What are 401(k) contribution limits?

401(k) contributions offer more fiscal freedom than an IRA. In 2019, both contribution limits have increased by a respective $500 dollars, but catch-up contributions for investors over 50 years old remain unchanged:

Annual Contribution

Annual Catch-Up Contribution

Total

401(k)s

$19,000

$6,000

$25,000

IRAs

$6,000

$1,000

$7,000

Total

$25,000

$7,000

$31,000

IRS.gov. Data as of Nov. 1 2019.

How do 401(k)s differ?

Traditional and Roth 401(k) plans differ in terms of the tax benefits they offer. A traditional 401(k) plan is sometimes referred to as a pre-tax 401(k), meaning that you contribute to the plan with before-tax dollars. But, because you don’t pay taxes on the money you put into the plan, you will have to pay taxes (both federal and most state income taxes) when you withdraw the money.

With a Roth 401(k) plan, the opposite is true. You contribute a portion of your salary to your Roth 401(k) plan with after-tax dollars. Because you’ve already paid taxes, when you begin to make withdrawals from the plan, that income won’t be taxed – it’s what’s called a qualified distribution. A distribution (or withdrawal) is considered qualified if you’ve had the account for at least five years and you made the withdrawal either due to disability or on or after you turned 59½ (the age at which you can start to withdraw money from the account without incurring an early-withdrawal penalty).

Are 401(k) distributions taxable?

Traditional

Roth

Contributions

Made on a pre-tax basis

Made on an after-tax basis

Withdrawals

Subject to income tax

Tax-free after age 59 ½*

*Only if the distribution satisfies certain conditions, for example that it has been at least five years since the first Roth contribution, or that the participant is disabled.

IRS.gov. Data as of Oct. 2018.

How does 401(k) matching work?

Employers will have their own methods and rules for matching 401(k) contributions. Importantly, a match does not mean that an employer matches dollar-for-dollar what you invest. Rather, employers typically match up to a certain percent of your salary or your contribution, with a chance to change over time depending on your length of tenure.

According to a 2015 Bureau of Labor Statistics study, the average annual 401(k) employer match is 3.5% of an employee’s salary. If you have company matching on your 401(k) plan, be sure to take advantage of meeting those requirements for your own contributions, as it is a simple and effective way to bolster your retirement savings.

When can I withdraw from my 401(k)?

When it comes time to withdraw your money in retirement, traditional 401(k) plans have certain distribution requirements, which typically begin the year you turn 70½. Because Roth 401(k) contributions are made with after-tax dollars, the withdrawals are not subject to the same required minimum distributions.

Aside from tax implications and early-withdrawal penalties, there are other considerations — such as where to invest — when choosing a withdrawal strategy for your 401(k) plan:

  • Many people take all of their money out of their 401(k) plan when they retire and roll it into an IRA, so they can manage it on their own or with an advisor. However, it may be beneficial to remain at least partially invested in the plan.
  • Many plans actually want you to stay invested in the plan, as they can negotiate lower fees with vendors when they have more assets. These lower fees may make it advantageous to stay in the plan versus selecting investment options outside à la carte.
  • In addition, if your 401(k) plan is invested in a target date fund, it may offer an investment mix that's designed to help meet the needs of people in retirement.

401(k) plans can be very useful tools in saving for retirement, particularly if you take advantage of features that your plan may offer to help maximize your savings. There are many different ways to start saving for retirement. The trick is to find the right combination of savings plans and tools that work for you. For more on what to consider when selecting a plan, the IRS website offers valuable insight.