Your 401k Explained
A 401k is one of the most popular tools people use to build wealth.
1. As of 2019, 401k plans had US$6.4 trillion in assets
Employees have a lot of money within these accounts.
2. What is a 401k?
The 401k is an employer-sponsored, defined-contribution, personal pension. On a periodic basis contributions are made directly from an employee's earnings into the 401k plan.
3. Tax Deferred
Any contributions an employee makes are not taxed today, but instead when the money is distributed starting at 59 1/2. Distributions are taxed as ordinary income.
4. RMDs - Require Minimum Distributions.
Individuals are required to withdraw money from their 401k accounts at the age of 72. This age may change in the future.
5. Employer match
Employers typically match a percentage of employee contributions up to specific amount of the employee's earnings.
A common match practice is that an employer will $0.50 for every dollar an employee contributes up to 6% of your salary.
If an employer offers a 401k, not all do, then they also determine how much they want to match funds, not all do. Some employers are more generous with matching than others.
6. 2023 - $22,500
This is the total amount that an employee is allowed to contribute to a 401k in one year. This maximum number generally goes up over time.
7. Should you still contribute to a 401k even if your employer does not match?
It depends. If you are in a high tax bracket any funds you contribute to a 401k reduce your current taxable income.
8. 401k fees
There are definitely fees. The fees primarily comes from 2 places. The 401k provider fees and the fund provider fees. These vary by provider, but you it is important to do your research and know what you are paying in fees.
Generally, the larger the fund or the larger the organization the lower the fee structure is per individual.
9. Transferring a 401k to a Traditional IRA
Whenever you leave an employer you may consider rolling over your 401k funds to a traditional IRA.
- You could pay lower fees
- You could have more investment options
- You could have more control over the funds within the account
The employee does not have much control over the funds in a 401k. But when you transfer to a traditional IRA you get more flexibility and the funds remain tax-deferred until they distributed.
10. The funds
A 401k has a limited number of funds to invest into.
- What is your risk tolerance?
- What are the fees associated with each fund?
- How many funds do you really need to reach your goal?