Guide to Your Company 401K

Whether starting a new job or reviewing next year’s options, company benefits can save you money and help prepare for your future. Many companies offer employees health insurance, life insurance, and retirement plans which build a strong financial future beyond earnings. Taking the time to understand your company 401K plan will help you get the most from this valuable benefit.

Most consumers have access to retirement accounts both through independent accounts and connected to employment. Company retirement benefits offer a way to automate savings, simplifying the process, and growing retirement funds faster. The sooner you begin to set aside money, the more you will have when you reach retirement. Increased life expectancy, means seniors retiring now can expect to live decades in retirement, making it more important than ever to participate in these plans, when available.

Private companies offer 401Ks which provide tax incentives to encourage participation. Other types of company retirement accounts include 403Bs (non-profit organizations), 457Bs, or TSPs (government employment), provide similar benefits.

How 401Ks Work

Company Plans are either automatic or voluntary. Automatic enrollment deducts a minimum amount from your check and invests the money conservatively. Voluntary plans require you to act, in order to participate. Either way, you typically decide how much of your paycheck (usually pre-tax dollars) to contribute towards your retirement plan. Each pay period a percentage of your income adds to existing account balances.

In addition to choosing the amount to contribute you must also select where the money goes. Failure to take the second step could lead to contributions sitting in a cash savings account until you direct the funds elsewhere. Typically, the company offers a range of mutual funds and possibly company stock as investment options within the 401K.

Tax Benefits

Every payday, your employer deducts a predetermined amount from your paycheck before taxes. These funds purchase the investments you selected. The money placed in the 401K are not taxed before contributions and grow tax-free until withdrawn. You pay taxes at the time of withdrawal on the full balance. The technical term for this transaction is called a pretax contribution. 401K investments reduce taxable income in the year of the contribution.

Choosing Investments

Employers select pre-determined investment choices which typically consist of mutual funds with varying levels of risk. A mutual fund is essentially a group of company stocks or bonds bundled into one fund. They offer diversification, lower risk, and more stability than investing in individual stocks or bonds. They require less money and allow you to purchase partial shares, making them a good fit for the regular contributions of a 401K.

The employer cannot advise you on an investment strategy.

How Much to Invest

Most companies allow you to adjust the level of contribution on your benefits page anytime you want. At a minimum, you should invest to the company match, which can double the investment dollars each paycheck. The average employee works 40 years and with higher life expectancies it is not unrealistic to fund 30 years of retirement. In that respect, the more, the better. Start with a percentage you are comfortable with and then increase the amount by 1% every six months or every year.

Financial experts recommend saving a minimum of 10% for young adults and 20% or more for those over 40, who are behind in retirement savings.

Employer Match

Many companies match the amount of money invested in a retirement account. Matches can be up to 100% of a percentage of your contributions. For instance, if your company offers a 100% match up to 6%, it means if you contribute 6% of your pay the company will add 6% resulting in 12% of your income building retirement accounts. A match is free money from your employer.

Limits of Contributions

There is a limit to the amount you may add to retirement accounts and still gain the tax benefits.

Those under 50 can invest up to $18,000, where those over 50 have an additional $6,000 for a cap of $24,000 annually. With an employer match, the maximum annual contribution to a 401K account may not exceed 53,000.

Withdrawal from A 401K Account

To gain the maximum tax benefits funds must remain in the account until you reach 59 ½. Funds taken prior to this time owe a 10% tax penalty unless they meet one of the limited exceptions. You pay income taxes when you withdraw funds on the full amount.

Required Mandatory Distributions or RMDs must begin by the age of 70 ½. Failure to comply could leave you taxed at 50% on the required distribution amount.

“Borrowing” From The 401K Account

You may take out a loan on your 401K account without accruing any penalties. The company determines the amount of money you may borrow but typically limit loans to 50% of the balance. The required repayment period cannot extend beyond five years, and typically the company auto deducts payments from each paycheck. Failure to repay the loan within this time will result in a distribution and potentially a 10% penalty plus taxes, on any remaining balance. Changing employers will also result in required repayment within 60 days of leaving the job, to prevent the balance from being counted as a distribution and taxed.

Transferring A 401K

Switching employers allow you to take the 401K with you. Depending on the balance you may leave it with the previous employer, move it to the new 401K plan, or transfer it to an IRA (Individual Retirement Account). As long as a direct transfer occurs, there are no tax consequences. If you choose to receive a check, you have 60 calendar days to deposit the funds into an approved account to avoid taxation and possible penalties.

A 401K account is a very helpful tool for retirement planning. It automated the process and will set aside a certain percentage of your income before you ever see it. Because of tax penalties, there is a strong incentive to leave the funds in place until retirement.