Make the Most out of your 401(k)

November 04, 2015

As more Americans shoulder the responsibility of funding their own retirement, many rely increasingly on their 401(k) retirement plans to provide the means to meet their investment goals. That’s because 401(k) plans offer a variety of attractive features that make investing for the future easy. Here are some things to help you better understand your 401(k):

What is a 401(k)?
It is an employee funded savings plan for retirement.

Tax Treatment of 401(k) Plans
The 401(k) plan allows you to contribute up to $18,000 of your salary. Future contribution limits will be adjusted for inflation. If you are over the age of 50, you can contribute “catch up” contribution of an additional $6,000 per year.

401(k) plans now come in two varieties: Traditional and Roth-style plans. A Traditional 401(k) plan allows you to defer taxes on the portion of your salary contributed to the plan until the funds are withdrawn in retirement, at which point contributions and earnings are taxes as ordinary income. In addition, because the amount of your pre-tax contribution is deducted directly form your paycheck, your taxable income is reduced, which in turn lowers your tax burden.

The tax treatment of the Roth 401(k) plan is different. Under this plan, contributions are made in after-tax dollars so there is no immediate tax benefit. However, plan balances grow tax free; you pay no taxes on qualified distributions.

Matching Contributions
One of the biggest advantages of the 401(k) plan is that employers may match part or all of the contributions you make to your plan. Typically, an employer will match a portion of your contributions. Under a Roth plan, matching contributions are maintained in a  separate tax-deferred account, which like a traditional 401(k) plan, is taxable when withdrawn. Employer contributions may require a vesting period before you have full claim to the money and investment earnings.

Choosing Investments
Generally, 401(k) plans provide you with several options in which to invest your contributions. Such options may include stocks for growth, bonds for income, or other investment options This flexibility allows you to spread out your contributions, or diversify, among different types of investments, which can help keep your retirement portfolio from being overly susceptible to different events that could affect the markets.

When You Change Jobs
When you change jobs or retire, you generally have four different options for what to do with your plan balance. You can keep the plan in your former employer's plan, if permitted; you can transfer balances to your new employer's plan; you can roll over the balance into an IRA; or you can take a cash distribution. The first three options generally entail no immediate tax consequences; however, taking a cash distribution will usually trigger 20% withholding, a 10% IRS penalty tax if taken before age 59½, and ordinary income tax on pre-tax contributions and earnings.

When deciding on which of the first three options to choose, you should consider available investment options and ease of access. Often, rolling over to an IRA may provide flexibility and control, while affording a wide choice of investment alternatives.

To meet with one of our advisors to discuss your 401(k) plan call us at 763-231-9510 or email Katherine@prosperwell.com.

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