How does a 401k plan work?

A 401k plan is most workers best way to save for retirement. It has great tax advantages and is creditor protected. Many great 401k plans also provide investors economies of scale and substantially reduced fees and expenses.

With all of the good things 401k plans can be complex. Here are some 401k plan basics you need to know.

401k plan savings limits:

The amount you can save towards retirement depends entirely on your age. In 401k, 403b, and most 457 plans for the calendar year of 2015 and 2016, you can contribute $18,000 if you’re the age of 49 and under. If you’ve reached age 50, you can make what is referred to as a catch up contribution in the amount of an additional $6,000.

 

401k investing shouldn't be hard!

401k plans don’t have to be complicated. Hit the green button and read your summary plan description.

How do I allocate my 401(k) investments?

First you need to decide whether to create your own custom investment portfolio from the list of fund options or go with an asset allocation or target retirement date fund. Asset allocation funds are mutual funds that provide investors with fully diversified portfolios of different risk levels in one package. They are great options for those investors who want to “keep it simple”.

Once you’ve decided to build your own portfolio or select one that’s created for you, you’ll need to select your mutual fund (or mutual funds) from your 401(k) plan investment options.

The ratio between stocks and bonds is the single most important factor in determining your investment risk and returns. A great place to start would be to take a risk profile questionnaire.

Where does my 401(k) money go?

When you invest in your 401(k) your contributions are deducted directly from your paycheck, but your employer doesn’t take custody of those contributions. Both your elective deferrals and your employer’s matching contributions are held at a separate custodian. Generally, that custodian will be one of the big brokerage firms like Charles Schwab or TD Ameritrade. Other 401(k) custodians are insurance companies such as VOYA or John Hancock. The 401(k) plan custodian will designate separate accounts for each employee and may even have sub-accounts designated to keep separate both ROTH contributions and traditional contributions.

How do I get my 401(k) money out?

The big payoff of saving towards your retirement in a 401(k) plan is when you can withdraw the funds and put them to good use in retirement. After you’ve finished working, you’ll start by rolling over your 401(k) into an IRA so you can begin taking withdrawals at your leisure. Keep in mind that everything withdrawn from a traditional IRA is taxed as ordinary income in the year you withdraw it. If you’ve made an ROTH 401(k) contributions, you’ll start by rolling those over into a separate ROTH IRA. For both account types, you’ll need to have attained age 59 1/2 when withdrawing funds to avoid a 10% penalty on the full withdrawal if pre-tax contributions were made, or the growth of your accounts for ROTH 401(k) contributions. Roth’s must have also had to have been active for at least five years.