Guide: Understanding Your 401k Retirement Plan

Key points

  • 401k plans are workplace retirement savings accounts that can offer tax advantages.

  • You have several options for what to do with your 401k when you change jobs, including rolling it over into a new employer plan, an IRA, or cashing it out.

  • When saving for retirement, you should consider investing in both 401(k) and IRA plans to take advantage of the tax benefits and higher annual contributions associated with 401(k)s.

  • Withdrawing from your 401(k) is relatively straightforward once you have completed the necessary paperwork. 

  • It's important to save for retirement by investing 10% of your take-home pay into 401(k) plans and taking advantage of employer matching contributions if available.

What is a 401k?

A 401(k) is a retirement savings plan offered by employers to their employees. It allows you to save and invest a portion of your paycheck on a pre-tax basis.

You then get some choice as to how your money is invested usually with at least 3 options. As you save and your investments grow, they can provide you with a steady stream of income in retirement.

Not only that, but some employers may match part or all of your contributions, thus giving you an additional incentive to save.

This is really important. If your employer matches your contribution, they are basically giving you money for free. You MUST take it.

Traditional 401(k) and other variations

On top of the standard 401(k) mentioned above, there are a few other types of 401(k) that you should be aware about:

  • Simple 401(k) Plan – this is a simplified version of a traditional 401(k) plan. It requires less paperwork and is designed for small businesses with fewer than 100 employees.
  • Roth 401(k) Plan - this is like a traditional 401(k) plan, except that contributions are made with after-tax dollars. This means that when you withdraw your money in retirement, you won't owe any taxes on the money.
  • Safe Harbor 401(k) Plan - a safe harbor 401(k) plan is similar to a traditional 401(k) plan, except that employers are required to make a minimum contribution to their employees’ accounts. This helps employees save more for retirement.
  • Solo 401k Plan - a retirement plan for small business owners or self-employed individuals who have no full-time employees other than their spouse. It allows for higher contributions than a traditional Individual Retirement Account (IRA) and includes employer and employee contributions.

Am I eligible for a 401k?

To be eligible for a 401(k) plan, you must be:

  • Be at least 21 years old
  • Be a U.S. citizen or a resident alien with a valid Social Security number
  • Be employed by an employer that offers a 401(k) plan
  • Be making at least enough money to contribute the minimum amount required by the employer's plan
  • Not exceed the annual contribution limits set by the IRS

Benefits of 401(k) Retirement Plans

A 401(k) is a great tool for retirement planning and saving that offers many unique benefits:

  • Tax Savings - the biggest benefits of a 401(k) retirement plan is the tax savings. Contributions to a 401(k) are made from pre-tax earnings, meaning that you don't have to pay taxes on the money you contribute so you have more money growing for your retirement
  • Employer Match - many employers offer a 401(k) match, meaning that the employer will match your contributions up to a certain percentage. This is a great way to increase your retirement savings and take advantage of free money.
  • Investment Options - 401(k) plans typically offer a variety of investment options, allowing you to choose investments that best fit your goals. This can be helpful if you want to focus on different types of investments and diversify your portfolio.
  • Low Fees - 401(k) plan fees are usually quite low, meaning that you can maximize your returns and keep more of your money in your retirement account.
  • Long-Term Savings - a 401(k) retirement plan is a great way to save for the long term. Since the money is invested for the future, you can take advantage of compound interest and make the most of your savings.
  • Retirement Security - with a 401(k) plan, you can plan for a secure retirement. This is a great way to save enough money to live comfortably in retirement, without having to worry about running out of finances.

How to make contributions

Making contributions to your 401(k) plan is an important part of building your retirement nest egg. Fortunately, it's super easy and convenient.

Most 401(k) plans allow you to set up direct deductions from your paycheck, so that you don't have to worry about remembering to make contributions.

You can decide how much you want to contribute each pay period, up to the annual limit set by the IRS.

You can also change your contribution amount at any time, as long as you stay within the IRS limits.

What are 401k contribution limits in 2023?

There are limits that you need to be aware of in order to ensure that you don't over contribute to our 401(k) plan. These limits are set by the IRS.

In 2023, if you are under the age of 50 your maximum 401(k) contribution is $22,500.

If you're 50 or older, your maximum 401(k) contribution is $30,000 in 2023, because you're allowed $7,500 in catch-up contributions.

Keep in mind though that these limits do not include any employer contributions. But if the employer also contributes or you decide to make additional, non-deductible after-tax contributions to your traditional 401(k) plan, then the IRS also has a total employer-and-employee contribution limit for the year.

If you’re under the age of 50, total employee-employer combined contributions cannot exceed $66,000 annually.

If the catch-up contribution for individuals over 50 is included, then the limit goes up to $73,500.

Are 401k contributions taxed?

Whenever you contribute to your 401k, you are putting in pre-tax dollars, meaning that you don't pay any federal income tax on those contributions at the time you make them.

Furthermore, any matching contributions that your employer makes to your 401k is made with pre-tax dollars.

The money in your 401k grows tax-free, and you only pay taxes when you start to withdraw the money during retirement.

This can be a great way to save money in the long run, since you are only paying tax on the money you withdraw, not the entire amount you contributed.

What is a 401(k) distribution?

A 401(k) distribution is a withdrawal from your 401k retirement plan. This makes it a great financial tool for those seeking to supplement their income or to pay for expenses.

You can withdraw a lump sum or arrange for regular payments to be sent to you. Depending on your plan, you may be able to access your funds as soon as the day after you request the distribution.

401(k) distributions are generally subject to taxes and penalties.

Distributions taken before age 59 ½ may be subject to an additional 10% federal income tax penalty.

It is strongly recommended that you do NOT take 401(k) distributions until you are at least 59 ½.

How are 401(k) withdrawals taxed?

401(k) withdrawals are taxed as ordinary income. This means that the amount of the withdrawal is added to your total taxable income for the year.

Depending on your tax bracket, the amount of taxes you owe on the withdrawal can vary.
The amount of the withdrawal is also subject to a 10% early withdrawal penalty if you are under the age of 59½ unless you are eligible for an exception.

For traditional 401(k)s, pre-tax contributions and any earnings on those contributions are subject to taxation. Withdrawals from a Roth 401(k) are not subject to taxation, as the contributions were made with after-tax dollars.

However, any earnings on those contributions are subject to taxation if withdrawn prior to age 59½, and the 10% early withdrawal penalty applies.

What is a 401k rollover?

A 401k rollover is a process that allows you to move money from an existing 401k account into another retirement savings plan, such as an IRA.

It's a great way to consolidate your investments and gain more control over your retirement savings into one place.

Rollovers can help you minimize taxes, fees, and other expenses associated with maintaining multiple retirement accounts.

With a 401k rollover, you can also take advantage of wider investment opportunities, such as stocks, bonds, and mutual funds.

Plus, you can move your 401k to an IRA that provides more options for managing and withdrawing your retirement savings.

What happens to my 401k when I change jobs?

When you change jobs, you have several options for what to do with your 401k. You can leave the funds in the old plan, roll it over into a new employer plan, roll it over into an IRA, or cash it out.

If you are younger than 59 1/2, you may be subject to federal and state income tax and a 10% early withdrawal penalty if you choose to cash out your 401k.

What is a Roth 401(k) plan?

A Roth 401(k) is a retirement plan that offers tax-free withdrawals. It is similar to a traditional 401(k) plan, but the contributions are made with after-tax dollars and the distributions are tax-free.

This means that when you retire and begin taking withdrawals, you will not have to pay any taxes on the withdrawals.

This makes a Roth 401k an attractive option for those looking to save for retirement in a tax-advantaged way.

Unlike a traditional 401k, Roth 401ks do not have required minimum distributions, so you can keep your money in the account and continue to earn tax-free income.

What is an IRA?

An Individual Retirement Account (IRA) is a tax advantaged retirement savings account  that can be opened via banks or other financial institutions.

Contributions to an IRA are generally tax-deductible, and earnings on investments within the account are not taxed until a withdrawal is made.

Depending on the type of IRA, withdrawals may be taxed at the time of withdrawal or deferred until retirement. While an IRA allows more investments, 401(k)s allow higher annual contributions.

How much money should I save for retirement?

When it comes to saving money for retirement, there is no single answer as to how much should be saved.

It depends on a variety of factors, including your income, age, current financial situation, and investment strategy.

At Grow Today, we think you should definitely invest into your 401(k) and take an matching contribution from your employer.

On top of that if you invest 10% of your take home pay then it is going to go a long way towards getting you to financial freedom earlier or with more money available.

Withdrawing from your 401(k)

Withdrawing from a 401(k) is a relatively straightforward process. The first step is to contact your 401(k) plan administrator to request a withdrawal form.

Once you complete the form, you will need to provide a copy of your driver's license or other form of identification to verify your identity.

You also should specify how much you wish to withdraw from your account, as well as the type of withdrawal you want to make.

Withdrawal options may include taking a lump-sum distribution, taking periodic withdrawals, or rolling the funds into an IRA or other retirement plan.

Once your withdrawal request is approved, the plan administrator will make the funds available to you according to the withdrawal type you selected.