A 401(k) plan is an employer-sponsored retirement savings plan that allows employees to save or invest a part of their paycheck before taxes are taken out. Taxes on the money invested are not due and payable until the money is withdrawn from the employee's 401(k) plan account. The following are some helpful tips to make the most of the 401(k) plan available to you.
1. Save Early and Aggressively for Maximum Results
Save as much as you can as early as you can in order to maximize the amount of funds available to you upon retirement. Although the amount of employee contributions to their 401(k) account is limited, 401(k) accounts can receive a greater amount of money than Individual Retirement Accounts (“IRAs”) can. The contribution limit in 2016 is $18,000 for 401(k) plan participants under age 50 and $24,000 for 401(k) plan participants age 50 or older.
2. Take Advantage of Employer Matches
Take advantage of any available “matching” contributions from your employer. As an example, say your 401(k) plan provides that your employer will match 50% of your contributions, up to 6% of your salary ($80,000). If you contribute 6% ($4,800), your employer will contribute an additional 3% ($2,400) - resulting in $2,400 of free money available to you upon retirement. It is not mandatory to contribute the maximum percentage of your salary to your 401(k) account, but it is advisable to contribute enough to maximize your employer's matching contributions (and ultimately, your retirement funds).
3. Don't Cash Out or Borrow from Your 401(k) Account
Cashing out your 401(k) account every time you change jobs may result in immediate funds, but doing so could result in a great loss of money available to you upon retirement. Even if your employment was short and you only have $20,000 available in your 401(k) account, the $20,000 will continue to accumulate even after termination from your employer, depending on the average annual growth rate. Similarly, don't borrow money from your 401(k) account unless it's an emergency.
4. Remember Your 401(k) Account Is Only a Part of Your Overall Retirement Portfolio
Your 401(k) account is not your only option when it comes to retirement planning and saving; your overall retirement portfolio may also include non-retirement investment brokerage accounts and/or one or more IRAs. Consult your financial advisor or Butterfield Schechter LLP for more information regarding the different retirement options available to you and the best strategy to maximize your retirement funds.
5. Consider the Roth 401(k)
Many employers now offer two different kinds of 401(k) accounts - traditional and Roth. As discussed above, with a traditional 401(k), you contribute pre-tax money and as a result reduce both your taxable income and tax bill for the year. With Roth 401(k)s, you contribute post-tax money and therefore do not receive any upfront tax break. Upon retirement, however, you will receive the full amount in your Roth 401(k) account (tax free) if you follow the requirements set forth in the Internal Revenue Code. Contact Butterfield Schechter LLP for more information.