A 401k retirement plan is a powerful tool to plan for the future you envision. It is the most common employer-sponsored retirement plan. Overall, they are fairly flexible and offer a variety of benefits to participants. However, it is essential to understand your options and limitations in order to make the most of your 401k.
Setting up 401K plan
Most employers have a variety of plan options, investment options, and matching choices to select. Carefully review your options and speak with an advisor on how you can maximize your saving and create a tax strategy that fits your goals.
Employees make pre-tax contributions to the traditional 401(k) reducing their taxable income for the year.
Contributions into a Roth 401k are made after-taxes which does not reduce your taxable income now but will help you avoid taxes in retirement. Because you already paid taxes on the money that you put into the Roth account, distributions from this account will be tax-free in retirement.
IMPORTANT NOTE: Know your contributions limits to avoid a double tax on your excess contributions. If you contribute more than the IRS allows you to contribute for that year, you will have to report that amount as taxable income AND then you will pay Federal taxes on that money when you withdraw it in retirement meaning you are paying taxes twice on that excess contribution.
When you leave a job, you have several options on what you can do with your 401k plan. Each option has pros and cons that come along with it. We outline some key areas to pay attention to when consolidating or moving your 401k plan.
IMPORTANT NOTE: The taxable portion of your withdrawal that is eligible for rollover into an individual retirement account (IRA) or another employer's retirement plan is subject to 20% mandatory federal income tax withholding, unless it is directly rolled over to an IRA or another employer plan.
If you withdraw money from your 401k before reaching 59½ you could be taxed twice. You will be charged a penalty tax of 10% on the amount you withdraw early and you will have to include this early withdrawal on your income tax return too! There are certain circumstances where you are allowed to withdraw funds early from your 401k without penalty.
There are specific rules about when you are required to begin taking distributions out of your account. You’re required to start taking RMDs from your 401k when you reach age 72.
The biggest retirement risk is running out of money. You worked hard for these savings. Take the time to develop a well-planned distribution strategy to know what will work for you. Some people pick a general 4% or 5% amount that they will withdraw each year in retirement. However, market volatility and inflation can derail this oversimplified plan.
IMPORTANT NOTE: If you have multiple 401k accounts then you will have to take an RMD from each of them.