Regardless of whether you’re 25 or 52, retirement is closer than you think. While you may have been contributing to a 401 k plan for years, you might not be aware of everything that entails and what is happening to your money while it is in this account. There are a few questions that pop up from time to time, and we would like to address some of the most frequently asked questions when it comes to 401 ks and retirement planning.
What is a 401 k plan, and how does it work?
This plan is one that is sponsored by employers, and it encourages employees to begin depositing a portion of their paychecks into an investment account. This tax-advantaged account allows you to select an investment option for your funds. About half of all assets in a 401 k plan will be invested in mutual funds. From there, they are invested in a number of stocks, bonds, and other short-term investment options. Employers will either offer a traditional 401 k account or a Roth 401 k plan.
In a traditional plan, the money will go straight into the account untaxed. Then, at the end of the year, this money is not counted as taxable income. This money will only be taxed when it is time to pull the money out of the account at 59 ½ years old. For a Roth account, the money is taxed as it enters the 401 k. When it’s time to remove the money for retirement, the withdrawals are tax-free (assuming that you adhere to the rules of withdrawal; otherwise, other penalties may be charged).
Where does 401 k get its name from? What is the origin?
These plans get their name from the section number and subsection of the IRS’ code that permits employees to avoid collecting on their income until a later date. This section was written to help figure out the best way to address the original rules and the issues that came along with them. Before the official rule was made, only a few employers offered any sort of retirement savings account to their employees.
Why should you invest in a 401 k plan?
These plans are, by far, the most popular and the most successful tools when it comes to finding great methods to save. They can help people with their tax planning, tax-deferred growth, and they offer employer matching opportunities.
With tax-planning, people get the opportunity to lower their taxable income levels. If you choose the Roth option, which is taxed as money enters your account, you will avoid a possible high tax bracket in the future when you retire. However, if you expect you will be in a lower income bracket when you withdraw from your 401 k, then a traditional account option may be the wiser choice. You can plan ahead based on what you are expected to earn in that time. If you are not sure what you will be earning, make sure to contact us at Kennedy Financial & Insurance Services to make an estimate of your future earnings.
Tax-deferred growth, another benefit of 401 k plans, refers to the money that has grown and compounded in your account. Since the money in this account is not taxed annually, it can grow much quicker than it would in your standard bank account.
Employer match options are offered at many companies across the country. These plans incentivize employees to contribute to their 401 k accounts by offering an additional contribution that adjusts depending on how much the employee adds.
What is vesting?
Some companies require you to work there for a set period of time before they allow you to access the money they have matched for you in your 401 k. You should know that the money you add to your own is solely yours, and that cannot be taken away. However, if they are matching you dollar for dollar, but have a vesting period of a year, then you must work for that company for a year before you have full access and ownership to the employer’s contributions.
Is there a limit on how much I can put in my 401 k?
Yes, there is. Employees may add up to $18,000 into a 401 k plan annually. However, if you are 50 or older, you are allowed to defer up to $24,000 as a catch-up contribution since retirement is so close at that point.
If you would like to learn more about your 401 k and your options, make sure to contact us at Kennedy Financial & Insurance Services. We would like to help you as you plan for your future and make the best possible choice to prepare for your retirement. Reach out to us today to learn more about how we can help you!