Save Now, Retire Well
Mastering Savings With The 401(k) Plan
Understanding The Retirement Savings 401(k) Plan
401(k)s are the most popular retirement savings plan, with over 60 million Americans using them. Despite their popularity, many people don't fully understand how they work. A 401(k) is an employer-sponsored retirement savings plan that offers tax benefits, which can vary depending on whether you choose traditional or Roth contributions. Employers often offer these plans to attract and retain employees.
How 401(k)s Work
Contributing to a 401(k) means setting aside a portion of each paycheck into a retirement account. These contributions can be invested in various mutual funds, such as index funds or target date funds. The major benefit is the potential for your investments to grow over time through compounding returns. Traditional 401(k) contributions are pre-tax, meaning you’ll pay taxes when you withdraw the money in retirement, whereas Roth 401(k) contributions are made with after-tax money, allowing for tax-free withdrawals later.
Advantages of 401(k)s
One significant advantage of 401(k)s is automation; contributions are automatically deducted from your paycheck, encouraging consistent saving. Additionally, many employers offer matching contributions, effectively giving you free money towards your retirement savings. The power of compounding—where your investment returns generate their own returns—can significantly enhance your retirement fund over the long term.
Contribution Limits and Rules
For 2024, the annual contribution limit for a 401(k) is $23,000 for those under 50, with an additional $7,500 catch-up contribution allowed for those 50 and older. It's important to stay within these limits to avoid penalties. Generally, you must wait until age 59½ to withdraw funds without incurring a 10% early withdrawal penalty, with few exceptions like financial hardship or medical expenses.
Managing Your 401(k)
When changing jobs, you have several options for your 401(k): leaving it with your former employer, rolling it over into an IRA, transferring it to your new employer’s 401(k), or cashing it out (which can incur taxes and penalties). After reaching age 73, you’re required to start taking minimum distributions to avoid hefty penalties.