Planning for your retirement is something that can span most of your working life, and the sooner you start saving, the better and more fruitful your nest egg years will be.
Contributing money to a 401(k) can be a prudent way to save up for your financial goals. A 401(k) is a retirement plan offered by an employer where qualified employees make recurring contributions from their pre-tax income.
401(k) plans are popular instruments for retirement planning. According to Investopedia, data provided by the Investment Company Institute shows that approximately $5.3 trillion of the $27.2 trillion in total retirement-plan assets in the United States were comprised of 401(k) plans as of Sep 30, 2017. It further states that there has been a more than 100% rise in total 401(k) plan balances between 2008 and 2017.
Furthermore, maxing out your 401(k) is generally the best way to gather a good sum for retirement with great tax benefits.
In order to make the most out of the benefits provided by your 401(k), here are three things you should know:
Contributions (Limits and the Matching Rule)
Even though the IRS allows you to contribute up to 100% of your income to a 401(k) plan, it’s best to adhere to the maximum employee contribution limit. It’s important to note that the maximum employee contribution for 2019 has been raised to $19,000 from $18,500 in 2018. Moreover, if you are 50 years or older, you can make a “catch-up” contribution of an extra $6,000 a year.
One can contribute to other retirement plans at the same time as well. Under IRS regulations, contributions to all retirement plans should not exceed $56,000 for 2019 (up from $55,000 in 2018), or 100% of the participant's compensation, whichever is lower. Meanwhile, the maximum annual contribution limit for 401(k) participants age 50 years or older is $62,000 for 2019.
Employers offering a 401(k) plan may make matching contributions to the plan on behalf of their qualified employees, called 401(k) matching. For instance, an employer that matches dollar-for-dollar would match one dollar for every dollar that you contribute to your 401(k). However, there are 401(k) matching limitations, with 3% of your salary being the most common and some companies opting for 8% of an employee’s salary as well.
Distributions
One can begin taking penalty-free distributions from their 401(k) once they reach 59 ½ years of age. But, if someone chooses to withdraw funds prior to that, they face a 10% early withdrawal penalty on whatever distribution they take.
Also, if someone cashes out their 401(k) after leaving a job before they turn 59 ½, it could be seen as an early distribution and that person will be subject to a penalty. However, if someone rolls over their 401(k) funds into another existing or new retirement plan, or starts a new retirement plan within 60 days of possessing the 401(k) funds, they can dodge the 10% penalty.
One exception to this rule is that if you are at least 55 when leaving the company that sponsors your 401(k), you will not be subjected to the 10% penalty for early withdrawals.
Additionally, one must begin taking required minimum distributions, or RMDs, after turning 70½. An individual’s first RMD is due by April 1 following the year they turn 70½. For instance, if Mr. X turns 70 ½ in September 2018, then his first RMD will be due by April 1, 2019.
RMDs are calculated based on an individual’s life expectancy and account balance. The penalty for neglecting your RMDs is 50% of the amount you do not withdraw, which means you lose $500 if you don’t take your RMD, which amounts to $1,000 for a given year.
But there is an exception to the RMD rule. If you are still employed with the company sponsoring your 401(k) and do not own anything more than or equal to 5% of the company, you can ignore RMDs while you keep working.
Tax Deductions
Traditional 401(k) accounts allow you to defer income tax payments on the funds you contribute until withdrawal. Being above-the-line tax deductions, these contributions reduce any taxable income immediately. For instance, an individual falling in the 25% tax slab will save $500 in taxes on contributions amounting to $2000.
One may also qualify for a tax break at the state level. According to experts, low-income savers may be eligible for the saver’s tax credit.
Meanwhile, there are after-tax investment options like a Roth 401(k). Here, the contributions are made after paying income taxes, but withdrawals are fully tax-free, and subject to certain conditions.
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Here are 3 Important Things to Know About Your 401(k)
Planning for your retirement is something that can span most of your working life, and the sooner you start saving, the better and more fruitful your nest egg years will be.
Contributing money to a 401(k) can be a prudent way to save up for your financial goals. A 401(k) is a retirement plan offered by an employer where qualified employees make recurring contributions from their pre-tax income.
401(k) plans are popular instruments for retirement planning. According to Investopedia, data provided by the Investment Company Institute shows that approximately $5.3 trillion of the $27.2 trillion in total retirement-plan assets in the United States were comprised of 401(k) plans as of Sep 30, 2017. It further states that there has been a more than 100% rise in total 401(k) plan balances between 2008 and 2017.
Furthermore, maxing out your 401(k) is generally the best way to gather a good sum for retirement with great tax benefits.
In order to make the most out of the benefits provided by your 401(k), here are three things you should know:
Contributions (Limits and the Matching Rule)
Even though the IRS allows you to contribute up to 100% of your income to a 401(k) plan, it’s best to adhere to the maximum employee contribution limit. It’s important to note that the maximum employee contribution for 2019 has been raised to $19,000 from $18,500 in 2018. Moreover, if you are 50 years or older, you can make a “catch-up” contribution of an extra $6,000 a year.
One can contribute to other retirement plans at the same time as well. Under IRS regulations, contributions to all retirement plans should not exceed $56,000 for 2019 (up from $55,000 in 2018), or 100% of the participant's compensation, whichever is lower. Meanwhile, the maximum annual contribution limit for 401(k) participants age 50 years or older is $62,000 for 2019.
Employers offering a 401(k) plan may make matching contributions to the plan on behalf of their qualified employees, called 401(k) matching. For instance, an employer that matches dollar-for-dollar would match one dollar for every dollar that you contribute to your 401(k). However, there are 401(k) matching limitations, with 3% of your salary being the most common and some companies opting for 8% of an employee’s salary as well.
Distributions
One can begin taking penalty-free distributions from their 401(k) once they reach 59 ½ years of age. But, if someone chooses to withdraw funds prior to that, they face a 10% early withdrawal penalty on whatever distribution they take.
Also, if someone cashes out their 401(k) after leaving a job before they turn 59 ½, it could be seen as an early distribution and that person will be subject to a penalty. However, if someone rolls over their 401(k) funds into another existing or new retirement plan, or starts a new retirement plan within 60 days of possessing the 401(k) funds, they can dodge the 10% penalty.
One exception to this rule is that if you are at least 55 when leaving the company that sponsors your 401(k), you will not be subjected to the 10% penalty for early withdrawals.
Additionally, one must begin taking required minimum distributions, or RMDs, after turning 70½. An individual’s first RMD is due by April 1 following the year they turn 70½. For instance, if Mr. X turns 70 ½ in September 2018, then his first RMD will be due by April 1, 2019.
RMDs are calculated based on an individual’s life expectancy and account balance. The penalty for neglecting your RMDs is 50% of the amount you do not withdraw, which means you lose $500 if you don’t take your RMD, which amounts to $1,000 for a given year.
But there is an exception to the RMD rule. If you are still employed with the company sponsoring your 401(k) and do not own anything more than or equal to 5% of the company, you can ignore RMDs while you keep working.
Tax Deductions
Traditional 401(k) accounts allow you to defer income tax payments on the funds you contribute until withdrawal. Being above-the-line tax deductions, these contributions reduce any taxable income immediately. For instance, an individual falling in the 25% tax slab will save $500 in taxes on contributions amounting to $2000.
One may also qualify for a tax break at the state level. According to experts, low-income savers may be eligible for the saver’s tax credit.
Meanwhile, there are after-tax investment options like a Roth 401(k). Here, the contributions are made after paying income taxes, but withdrawals are fully tax-free, and subject to certain conditions.
A Simple Way to Build Wealth
No matter what your financial goals are, investing in quality stocks is an option worth considering. Stocks have produced better returns than other kinds of investments over the years and generated significant wealth for shareholders. If you're interested in stocks but you're nervous about picking the right ones, Zacks can help. Our research team makes it simple to find long-term buys with long-term wealth-building potential. Starting today, you can see our private selection of stocks priced under $10, Warren Buffett-style value picks, dividend stocks and more. Click here for your sneak peak >>