What is a 401(k)?
401(k) is a retirement account sponsored by an employer.
Once sure the employer offers a 401(k) plan, the employee can opt to contribute a percentage of pre-tax salary to a 401(k).
These contributions are invested in CDs, stocks, mutual funds, bonds, and so on.
Do I Have Control Over Fund Investments?
Generally, no but many companies offer the option of a self-directed 401(k), beware though, this comes with its pros and cons, if you have no idea of how to invest, it’s better to leave it “automated”.
Pros of a self-directed 401(k)
◣ Diverse investment options
◣ Higher quality investments
Cons of a self-directed 401(k)
◣ Heavy fees
◣ Time-consuming research
Am I eligible for a 401(k)?
This is employer-dependent but it’s widely common for an employee to be at least 21 years old and have no less than one year of service at the company.
Once again, this is an employer-dependent decision, it will vary from case to case, some companies may opt to exclude certain employees of their plan altogether.
Does every employer offer a 401(k) plan?
Not every single one does, it’s not mandatory.
Most companies that offer retirement benefits also cover part-time workers.
Some small companies do not offer a retirement plan at all.
When self-employed, SEP IRA’s and solo 401(k)’s are both valid options.
How do I Save for Retirement When Working for a Company that Doesn’t Offer a Plan?
Companies have several reasons not to offer a 401(k), the most common ones being:
◣ They hire young people that are far from thinking about retirement
◣ They hire people living paycheck to paycheck
◣ They think it’s expensive to run a 401(k)
First, if you’re bothered by the lack of a retirement plan, schedule a meeting with your employer and question your options.
If a 401(k) is still out of reach after you meet your employer, consider switching to another company that offers the desired benefits.
In alternative to previous options, the obvious replacement for a 401(k) is an Individual Retirement Account (IRA).
401(k) vs IRA
The main difference between both is that a 401(k) is an employer-tied account and an IRA is individual.
IRA’s offer more options of Investments and 401(k) has higher annual contribution limits.
Contribution limit – $19.500 (2021) or $26.000 if 50 years old of age or older
Main Pros – High annual contribution limit, Employer Match (when offered), Easy Eligibility, Contributions lower taxable income.
Main Cons – Lack of control over Investments, Limited investment options, required minimum distributions begin at the age of 72 and are taxed as ordinary income.
Contribution limit – $6.000 (2021) or $7.000 if 50 years old or older
Main Pros – Broader Investment offers, not employer-sponsored, some early withdrawal exceptions
Main Cons – Lower contribution limits compared to a 401(k), 10% penalty over ordinary early withdrawals
Either one has its pros and cons, having both a 401(k) and an IRA is the best solution to secure a smooth retirement.
Matching contributions happen when an employer opts to contribute to their employee’s retirement plan.
These are based on the employee’s contributions, for instance, an employer can match a pre-established percentage of an employee’s contributions with or without a percentage or dollar cap (ex: 50% of the employee’s contributions up to $3.000).
A Clearer Example
Google’s 401k matching is 50% up to $8.250 yearly.
This means that an employee needs to contribute at least $16.500 to take full advantage of Google’s matching plan, anything above that value will not receive matching contributions.
Facebook offers different matching conditions, they match 50% up to a ceiling of 7% of an employee’s salary.
In this case, if a Facebook employee makes 100k/year and contributes $7.000, they will put in $3.500 and no more than that.
Why do Employers Match Contributions, What’s In It For Them?
Congratulations, If you asked this question, you know no one gives anything for free.
The good news is that the benefits an employer receives are not directly tied to the employee.
The employer match is often used as a recruit bait, everyone wants to be part of the company with better benefits, this is good for both the employer and the employee.
Ultimately, their match can be deducted on their corporate income tax returns, this is the main reason for an employer’s match, tax benefits.
When Can I Withdraw My Contributions?
You can start accessing your 401(k) funds penalty-free from the age of 59½, according to early withdrawals will come with a 10% penalty.
There is an exception to this, the rule of 55.
This rule is an IRS provision that allows penalty-free withdrawals at the age of 55 or older.
Whether you’ve been fired, or quit by yourself, the motive is indifferent, you can still go through your 401(k) penalty-free if you leave your employer in the calendar year you turn 55 or after.
This rule is applied starting at the age of 50 for public safety workers (ex: firefighters, police officers).
As an important note, while the withdrawals will be penalty absent, distributions will still count as taxable income.
What if I Want to Switch Jobs?
Your 401(k) will follow you, or not, it’s your choice.
Each employer has a different plan, if you feel like your current plan is better than the one offered by the company you’re heading to, you can keep your 401(k) with your current employer after you leave, if they allow you to do so.
Transfer your 401(k) to your new employer’s plan
If your new employer’s plan is more attractive to you, you can directly transfer your entire account balance without penalties and taxes.
Although I don’t recommend this, there’s the option to withdraw your funds immediately, 10% penalty will be applied in this case.
No taxes will be applied when transferring funds from a traditional 401(k) to a traditional IRA, however, taxes may be applied if you rollover from a different kind of 401(k) (ex: Roth 401(k)) or have a different kind of IRA (ex: Roth IRA).
What Happens to your 401(k) if you die?
Generally, your retirement funds will go to the person you’ve listed as your beneficiary (typically a spouse or children) with the plan administrator, no matter what your will states.
If you have no designated beneficiary or if he dies before you and you have no inheritors, the funds will be destined according to the plan’s document.