What is a 401(k)?
A 401(k) is a retirement savings plan sponsored by an employer. A 401(k) allows workers to invest a portion of their paycheck before taxes are taken out. Investment options include mutual funds composed of stocks, bonds, and money market investments. Target-date funds tend to be the most popular option. A target-date fund is a combination of stocks and bonds that gradually become more conservative as you reach retirement.
There are benefits for both the employee and the employer. If your employer doesn’t offer a 401k, you can still invest in an individual retirement account, which is commonly referred to as an IRA.
401k Employer Benefits:
- Attract talented people in today’s challenging job market
- Retain valuable employees who want retirement options in their benefits package
- Enjoy tax advantages that may be available to you as an employer offering the plan
401k Employee Benefits:
- Tax-deferred growth potential and pre-tax contributions
- Employee pays taxes only for employer contributions
- Taxes aren’t paid until the money is withdrawn from the account
- Plan fees
- Limited investment options
- Early withdrawal penalty
How Much Can You Invest Into A 401k?
The maximum amount that an employee may voluntarily defer into the plan varies each year. In 2019 individuals can contribute up to $19,000 a year ($25,000 if age 50 or older)
What are the early withdrawal penalties?
Generally though, if you take a money out from your IRA or 401k before age 59 ½, you will likely owe both federal income tax (taxed at your marginal tax rate) and a 10% penalty on the amount that you withdraw, in addition to any relevant state income tax.
What happens to my 401k if I leave or quit my job?
If you leave your job, you can roll over 401(k) funds into an IRA