What is a 401(k)?
A 401(k) is an employer sponsored retirement plan offered by many companies. Upon reaching eligibility, an employee can choose to contribute a portion of his or her compensation into the 401(k). Often times, an employer will offer a match for participating employees. The contributions will then be put into a 401(k) account for the employee, which will offer multiple investment options for this money. This money will grow tax deferred until retirement. Unless you are 59 ½ (55 under certain circumstances), this money cannot be withdrawn without a 10% tax penalty and ordinary income taxes.
What is a 401(k) match?
Many 401(k) plans offer a match to encourage employees to participate in the plan. This can be structured many ways, but most common is the safe harbor match. For participating employees, this match would be dollar for dollar on the first 3%, and 50 cents on the dollar for the next 2%. Essentially, if the employee puts in 5%, the employer matches a total of 4%. However, the employee must put in the full 5% of compensation to take advantage of the full match. Another benefit of this type of match is that it is fully vested immediately. In some plans, an employer’s contributions may have a vesting schedule, meaning the employee must work a certain length of time (usually 5-6 years) until the employer contributions are actually theirs.
Most Common 401(k) Contribution Options: Traditional 401(k) and Roth 401(k)
Traditional 401(k) contributions are made pre-tax, meaning it lowers the participants taxable income in the year they are made. Upon retirement, any sum withdrawn will be fully taxable at ordinary income levels. With the Roth 401(k), contributions are made after-tax so there is no tax benefit at the time of contribution. However, the account grows tax deferred, and withdrawals in retirement are tax free (if older than 59 ½ and the account has been open at least 5 years).
*The type of contributions does not affect the match as the match is based on total percentage of employee compensation contributed.
401(k) and Changing Jobs
If you change jobs, you have several options for your 401(k).
Leave it in the plan: If your vested balance is above $5,000, usually plans will allow you to keep your account with them.
Roll it into your new job’s 401(k): Many people like this option as their money is consolidated into one account. The investment options will vary from plan to plan, but overall, the options will be similar.
Roll it into an IRA: An IRA will offer you more investment and management options than a 401(k).
Take a distribution: This is the least preferable of all options as you will face a tax penalty and taxes if under 59 ½ (55 under certain circumstances).
Remember, the amount of the 401(k) that is transferrable will be the “vested” balance.
The information contained in this blog does not purport to be a complete description of 401(k) plans referred to in this material. It has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary and does not constitute a recommendation. Be sure to consider all of your available options and the applicable fees and features of each option before moving your retirement assets. Prior to making any investment decision, you should consult with your financial advisor about your individual situation.
