There’s no such thing as a dumb question, especially when it comes to your financial future. Unfortunately, lots of people are too afraid to ask questions about their retirement options, including the 401(k). To calm your fears and give you more confidence about your investing options, I’ve compiled a list of questions people often ask me about 401(k)s and provided the answers.
Why is it called a 401(k)?
You can thank your federal government for creating such a non-descriptive name for a retirement savings plan. Subsection 401(k) is a part of the Internal Revenue Code (IRC) that was set into law in 1978. Just in case you’re wondering, a 403(b) and 457(b) are also named from their subsections in the tax laws. No wonder people get confused about retirement!
What’s the difference between a 401(k) and an IRA?
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Both a 401(k) and an IRA (Individual Retirement Arrangement) are accounts you can use to save money for retirement, and both of them have tax benefits to help you make the most of your savings. However, you can only place money in a 401(k) if your employer provides it as a benefit (or if you are the sole owner of a business). On the other hand, anyone under age 70 and a half who earns income can open an IRA. Here are some other differences:
-Some employers offer automatic enrollment.
-$18,000 maximum contribution per year.
-At 51, max contribution per year is $24,000.
-Employer matching available.
-If you change employers, you can roll over to an IRA.
-Money isn’t taxed until you take it out at retirement.
-Generally no income limits on contributions.
-Can only invest in options available in company plan.
-You have to open the IRA yourself.
-Maximum $5,500 contribution per year.
-At 51, max contribution per year is $6,500.
-Employer matching rarely available.
-Can be converted to a Roth IRA.
-Money isn’t taxed until you take it out at retirement.
-Contributions limited by income.
-Variety of investment options: mutual funds, stocks, bonds, C.D.s, etc.
You’re not limited to one or the other for your retirement savings. You can invest in a 401(k) and an IRA at the same time. Consult an investing pro who knows the ins and outs of both types of accounts.
What’s the difference between a traditional 401(k) and a Roth 401(k)?
The Roth 401(k) is relatively new. The Roth part comes from the guy who sponsored the bill in Congress that makes a Roth 401(k) possible. Both a traditional 401(k) and a Roth 401(k) are available through employers who offer this benefit. However, there are some differences:
-Employers can match your contributions.
-Taxes are paid when money is taken out at retirement.
-Beneficial if your tax bracket will be lower in retirement.
-You can start taking money out at age 59 and a half.
-Minimum withdrawals required at age 70 and a half.
-Employers can match contributions in a separate account that will be taxed as income when you take it out in retirement.
-Money is taxed before you invest it, but the earnings and withdrawals are tax-free in retirement.
-Beneficial if your tax bracket will be higher in retirement.
-You can take money out at age 59 and a half and when account has been open five years.
-Can roll over money to a Roth IRA to avoid withdrawal requirement at age 70 and a half.
What do I do with my 401(k) if I lose my job?
Nobody wants to think about a retirement plan when they’ve just lost their job, but it’s important to pay attention to it. If you have a 401(k) and you change employers for any reason, you have three basic choices:
1. Do nothing. You could leave the money in the current plan if your former employer will allow it. It’s easy and convenient, but you may end up with higher fees than if you chose other options. And you can’t contribute to the account anymore.
2. You can roll over your money into a new employer’s plan. There are limits and rules regarding this, so it’s not usually your best option.
3. You can do a direct rollover into an IRA. Direct as in don’t ever touch the money. Ever. If you have an existing IRA, you can roll your 401(k) balance into that. If not, you can open an IRA through a brokerage firm, a mutual fund company or your investing professional. Go to the one of your choice and ask them to contact your former employer’s 401(k) plan administrator and find out what hoops to jump through. You’ll fill out forms authorizing the transfer. You’ll also meet with the IRA provider to choose your investments for your IRA.
Whatever you do, don’t cash out your 401(k). You’ll pay major taxes and penalties—40% or more, depending on your tax situation! Keep your paws off!
I’ve met my employer’s match but still have more money to invest. What do I do?
Congratulations! If you’re asking this question, then you’re killing it! You’re investing more than most people. Here’s the answer: If your employer offers a Roth 401(k) with good mutual fund options, you can invest all your retirement money there. Why? You get the match and you get tax-free growth on every penny you contribute. Since you’ve already paid taxes on that money, you won’t pay income taxes on withdrawals when you’re retired! If your employer doesn’t have the Roth option, invest in your 401(k) up to the match. Then put the rest in a Roth IRA.
Hopefully that helps answer some of your questions. When it comes to specific details, though, you need to meet with an investing professional to help you achieve your goals. Don’t be afraid to talk with them about anything you don’t understand. Your retirement future is too important to keep those questions to yourself.