Ready to invest for your retirement through your employer's 401(k) plan? Get the details you need here!
What is a 401(k) plan?
A 401(k) plan is an employer-sponsored qualified retirement plan that offers you the opportunity to put your own money away into the plan through payroll deductions. You may choose either a percentage or dollar amount that is withheld from your paycheck and then contributed into the 401(k) plan.
What is the maximum amount that I can contribute?
The maximum amount that anyone can contribute into the plan for calendar year 2023 is $22,500. If you are 50 years of age or older, you can put an additional $7,500 into the plan via a catch-up contribution, bringing the total contributions to $30,000.
Eligibility
Check with your employer to find out when you become eligible to participate.
Why Participate?
Participating in a 401(k) plan is an opportunity for you to save for retirement on either a tax-deferred or a tax-free basis. Social security may not cover all of your expenses; therefore, this is an opportunity for you to take charge of your own financial future.
Traditional (Pre-Tax) Contributions
You will receive a reduction in the amount of your taxable salary in that year, and the money inside the plan will grow tax deferred until you take your money out of the plan.
For example, if you make $100,000 and put 10% or $10,000 into the plan, you will only be taxed on $90,000. The other $10,000 will NOT be taxed until you take that money out of the plan. If that money grows to $100,000 and then you take it out, you will now be taxed on the FULL $100,000 – the original $10,000 that you put into the plan, plus the $90,000 of growth.
Roth (Post-Tax) Contributions
Roth 401(k) contributions work the complete opposite of the Traditional 401(k). For example, if you make $100,000 and put 10% or $10,000 into a Roth 401(k), you will still be taxed on the full $100,000, but that $10,000 will continue to grow income tax free. If that $10,000 grows to $100,000 and then you take it out, you will owe NO income taxes on that money – nothing on the original $10,000 (because you already paid the taxes on this money) and nothing on the $90,000 of growth.
Which contribution type should you consider: Traditional or Roth?
You should consult with your tax advisor when making this type of decision, but, as a general rule, if you want to save taxes on the contributions that you make this year, then you should consider making Traditional 401(k) contributions. If getting the tax deduction this year is not a priority and you don’t want to have to pay taxes at any later date on the growth of this money, then you should consider making Roth 401(k) contributions.
Leaving Your Company – What should you do with your account?
There are four options:
- Leave it in the plan
- Roll it into a new 401(k) plan
- Roll it into an IRA
- Take a distribution
NOTE: The first three options have no tax consequences to them. The fourth one does. See Early Withdrawal Penalties below.
Have questions or need help opening an IRA? We have you covered. Contact Dawson Gonwick, Associate Financial Planner, at dawson@chichesterfinancial.com.
Taking Distributions in Retirement
For a Traditional 401(k), you may take money out without penalties starting at age 59½ until you are required to start taking Required Minimum Distributions (RMDs).
If you were born between 1950-1959, you must start taking RMDs at 72.
If you were born in 1960 or later, you must start taking RMDs at 73. Starting in 2033, the age will rise to 75. See more in our article about the Secure 2.0 Act.
The same rules apply to IRAs. NOTE: Unlike Roth IRAs, Roth 401(k)s are subject to RMDs; however, because you have already paid the tax on these contributions and this money has grown tax free, there are no income taxes owed.
Early Withdrawal Penalties
If you take a distribution from your 401(k) plan prior to the age of 59½ (with some exceptions), then you will have to pay a 10% penalty on that money. This is similar to the penalty for an early withdrawal from an IRA and is mandated by the IRS. If you made Traditional 401(k) contributions, then you would also be subject to income taxes on this distribution.
NOTE: Every situation is different, so please consult your CPA or tax professional before making any decisions with respect to your 401(k) plan.
