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Your Company Offers a 401(k). Now What?

While retirement may seem lightyears away, any seasoned financial professional will tell you that planning for your golden years should start as early as possible. While it can be hard to think so far ahead, your company may help you prepare for the future by offering a 401(k) plan.


A 401(k) is a retirement savings plan that is often part of many companies' benefits packages. This plan enables you to defer money from your paycheck to a 401(k) investment account. In addition to your personal contribution, many companies will also contribute money to your 401(k), "matching" a portion of your allocation. 


Usually, a pre-set amount will be deferred from your paycheck, but you can alter how much you want to put into your 401(k). Depending on your financial situation and your company’s offerings, you may dial the amount up or down. For example, if your employer matches exactly what you put in and you are financially stable, you usually will want to contribute as much as you can to your 401(k).

 

Understanding your company’s 401(k) plan is the first step to maximizing it.



investment 401k statements

Discover What Plan(s) Your Company Offers

Traditional Pre-Tax 401(k)

With a traditional 401(k), you save on taxes in two ways. First, you'll pay fewer income taxes since your reported salary is reduced by the amount put into your account. Second, the money inside the account grows tax-deferred, so you don’t have to pay tax on the gains yearly. You’ll only pay tax on the amount you withdraw during retirement.


Roth 401(k)

With a Roth 401(k), contributions are made with after-tax dollars, and you do not pay taxes on the amount withdrawn during retirement. Unlike the traditional 401(k), you’ll save on taxes in the future rather than in real-time. With this plan, you do not reduce your earned income by the amount contributed to your account. However, your account will grow tax-free, and you’ll withdraw money tax-free during retirement. 


Discover What Plan(s) Your Company Offers

Traditional Pre-Tax 401(k)

With a traditional 401(k), you save on taxes in two ways. First, you'll pay fewer income taxes since your reported salary is reduced by the amount put into your account. Second, the money inside the account grows tax-deferred, so you don’t have to pay tax on the gains yearly. You’ll only pay tax on the amount you withdraw during retirement.


Roth 401(k)

With a Roth 401(k), contributions are made with after-tax dollars, and you do not pay taxes on the amount withdrawn during retirement. Unlike the traditional 401(k), you’ll save on taxes in the future rather than in real time. With this plan, you do not reduce your earned income by the amount contributed to your account. However, your account will grow tax-free, and you’ll withdraw money tax-free during retirement. 


Contribution Limits

The contribution limit for the tax year 2020 will be $19,500 per individual. The combined contributions are capped at $19,500 if you have multiple plans.


Choosing the Right 401(k) Plan for Your Situation

If your employer offers a pre-tax 401(k) and a Roth 401(k), you must decide which plan is right for you. You’ll pay taxes on a pre-tax 401(k) when withdrawing, but you’ll pay taxes on Roth 401(k) contributions now, and this difference will play a role in choosing the best plan for your needs.


Usually, it makes sense to make Roth contributions in the early stages of your career when most people have a lower salary because your tax rate will not be as high. In this way, the impact on your dollars will not be as severe as with a higher tax rate due to a higher salary. On the other hand, you may prefer to make pre-tax contributions during the later stages of your career when your salary is higher because your tax rate will also be greater.


Should You Also Open an IRA?

Aside from your employer’s 401(k) plan, you can open an Individual Retirement Account (IRA). This may be a wise option for those in the early stage of their career, but their employer only offers a pre-tax 401(k). In this scenario, opening a Roth IRA enables you to make after-tax contributions at a time when you have a lower tax rate.


Understand Your Investment Options

Many plans will allow you to choose between multiple types of investments, like different mutual funds. You’ll want to explore these options and consider which fits your circumstances thoroughly.


Is Your Employer Contributing to Your 401(k)?

Your employer will contribute to your 401(k) in many scenarios. These contributions are pre-tax, so you’ll only pay taxes on the money when it’s withdrawn in retirement. There are several types of employer contributions:


1. Matching

With a matching employer contribution, your employer contributes the same amount as you. In some circumstances, there is a minimum amount to which your employer will contribute. If this is the case, some may contribute at least the minimum.


2. Non-Elective

A non-elective employer contribution means that the employer contributes the same percentage for every employee, even if the employee is not contributing. 


3. Profit-Sharing

In a profit-sharing 401(k), employers will delegate a percentage or dollar amount of the company’s profit to employees’ 401(k) accounts. 


Find Out When Your Employer Contribution Dollars Are Yours

Frequently, an employee can only keep his or her employer’s contributions after a certain number of years in the company, otherwise known as “vesting.” When you’re vested after a certain number of years, you now own the contributions made by your employer. 


If you want to make the most of your employer’s plan, you’ll want to determine when you are vested. You may decide to part ways with your job only after you are vested, allowing you to take full advantage of your company’s 401(k) plan. 


Once you understand the specifics of your company’s 401(k) offerings, you’ll be able to decide how to best utilize the plan for your needs and goals.



Invest In a Life You Love,

Donovan Carson - founder of Carson Capital



 

Donovan-carson-founder-carson-capital

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