If you’re looking for a tax-advantaged way to build wealth for the future, one of the most attractive accounts out there is the 401k.
Many employers offer a 401k plan, so there’s a good chance you’ve already heard of this retirement account.
And if you set up your benefits so that you automatically contribute from your paycheck, you can build your nest egg without even thinking about. You might not even miss the money. Yet it will be working on your behalf.
Still not sure if this is the best retirement plan for you? Let’s dive in for a closer look.
What is a 401k?
For most people, the 401k is a tax-deferred account. This means you contribute money before your taxes are taken from your paycheck.
Additionally, a 401k acts as a tax deduction. So you end up with a lower tax bill because you are taxed on a smaller amount of money.
You don’t get out of paying taxes, though. Later, during retirement, when you withdraw money from your 401k, you pay taxes on the distributions.
And if you work for a public school or a tax-exempt organization, you might end up contributing to a 403b plan. This account is similar to the 401k and even has the same contribution limits.
Setting up your 401k through work
For the most part, the 401k is designed to be a workplace benefit. Your employer usually offers the retirement plan and arranges for its administration.
You normally then go through human resources to set up your benefits. Some companies even have you set up your plan as part of your new employee onboarding process.
While you’re filling out your W-4 and completing other paperwork, you might also be asked how much you want to withhold for your 401k.
Other employers require you to work for a certain period of time before signing you up for your 401k account. For example, you might wait 60 or 90 days before setting up your 401k plan.
No matter how long it takes, you’ll need to visit with your human resources representative to find out your options.
In many cases, your employer already has all the necessary information for establishing a plan from your hiring paperwork. You just need to decide how much money you want to be withheld from your paycheck.
401k: don’t leave free money on the table
One of the biggest advantages of participating in an employer-sponsored 401k plan is the possibility of a match.
As an incentive to encourage you to save, your employer might match a percentage of your contributions to your retirement account. This is essentially free money that helps you build your nest egg faster.
Employers usually choose a formula for making matching contributions. There are two main formulas for determining a 401k match:
1. 100 percent match up to a percentage of your income.
In this scenario, your employer will match you dollar for dollar, up to a certain amount.
Say your employer offers a 100 percent match of up to 3 percent of your annual income and you make $50,000 per year. This means that every dollar you put into your 401k account is matched until the employer has paid 3 percent of your income. Or, $1,500.
You can still contribute more, but it won’t be matched. So if you decide to contribute $4,000 a year, your total contribution will be $5,500 because of what your employer put in.
2. Partial match with a maximum limit.
With this option, your employer matches a portion of your contributions until you reach a certain percentage of your salary. In this scenario, your salary determines the upper limit for contributions eligible for the match.
Say your employer will match 50 percent of your contributions that equal up to 6 percent of your income. The annual contribution eligible for matching when you have a salary of $50,000 is $3,000.
However, your employer only matches 50 percent, so the total benefit from the employer is still $1,500.
No matter what the setup is, do your best to get the maximum match available. Free money is free money people.
Each year, the IRS reviews inflation rates and adjusts the contribution limit for the 401k.
Right now, for tax years 2016 and 2017, you can contribute up to $18,000 annually. And for those 50 and over, it’s possible to contribute an extra $6,000 a year as a “catch-up” contribution.
What’s more, with the 401k, you don’t have to worry about deduction phaseouts due to income.
Because the 401k is a tax-advantaged account, you aren’t supposed to start taking distributions until age 59 ½. And when you withdraw your money, it will be taxed at your marginal rate.
However, if you withdraw money before that age, you will pay taxes on the income. Plus a penalty imposed by the IRS.
It is possible to take a loan out against your 401k, too. Some people like this option because it’s not considered an early withdrawal.
Although you pay interest, you usually have five years to repay the loan. However, if you lose your job or switch jobs, the outstanding balance becomes due and you have to pay it back. Otherwise, it’s treated as an early withdrawal.
The 401k is also subject to required minimum distributions. So once you reach age 70 ½, a formula is used to determine how much you must withdraw each year.
Other types of 401k accounts
In some cases, you might have access to other types of 401k plans.
A few years ago, a Roth version of the 401k was introduced. This account has a higher contribution limit, but taxes are automatically taken out of your contributions. So the money grows tax-free, similar to the Roth IRA.
However, the Roth 401k isn’t subject to the income limits of the Roth IRA.
It’s also possible to open a solo 401k if you can find a bank or broker willing to help you go through the process. And, there’s a SIMPLE 401k for the self-employed.
Ultimately, the 401k is a great way for you to save for the future. And even if you don’t max out your 401k contributions each year, it’s a good idea to maximize your employer’s match.
Otherwise, that money just goes to waste rather than into your pocket.
Interested in refinancing student loans?Here are the top 6 lenders of 2019!
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1 Important Disclosures for SoFi.
2 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 7.89% APR (with Auto Pay). Variable rate loan rates range from 2.54% APR (with Auto Pay) to 7.27% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of March 18, 2019, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 0318/2019. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at firstname.lastname@example.org, or call 888-601-2801 for more information on ourstudent loan refinance product.
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3 Important Disclosures for Laurel Road.
Laurel Road Disclosures
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the fixed rate will decrease by 0.25%, and will increase back up to the regular fixed interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the variable rate will decrease by 0.25%, and will increase back up to the regular variable interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown.
All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 2.5% effective February 10, 2019.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.54% – 7.12%3||Undergrad & Graduate|
|2.54% – 7.27%1||Undergrad & Graduate|
|2.67% – 8.96%4||Undergrad & Graduate|
|3.23% – 6.65%2||Undergrad & Graduate|
|2.54% – 7.43%5||Undergrad & Graduate|
|2.98% – 9.72%6||Undergrad & Graduate|