By: Josh Slocum, McClellan Wealth Management
A 401(k) retirement plan is an employer-sponsored retirement savings program that enables employees to save for their retirement by making pre-tax contributions.
No matter if you’re just starting your career or have been in the workforce for a number of years, it’s never too early or too late to be thinking about retirement.
Whether you want to spend your retirement immersed in your favorite hobbies or traveling the world, the reality is that most Americans are painfully unprepared for their later years.
If you work for a company who provides a 401(k) retirement plan, the first step in preparing for retirement is to understand the basics. Although it is not perfect, it is the country’s most popular retirement fund options for saving for yourself and your family’s future. And, as with any investment, there are pros and cons.
With the start of a new year, it’s a great time to take a look at how your money can work for you.
What is a 401(k) plan and how does it work?
Many companies, especially those looking to attract top talent, offer 401(k) plans that allow employees to allocate a portion of their salary into a long-term investment. Some will even match an employee’s contribution up to a certain percentage or fixed amount.
Keep in mind, plans can have limited flexibility as it relates to the quality and quantity of investment options, and fees can be high especially in smaller company plans.
Still, with most employers moving away from pension plans, the 401(k) has become the most popular employer-sponsored retirement plan.
Is a 401(k) a qualified retirement plan?
Yes, a 401(k) is a qualified retirement plan, and this simply means it meets IRS requirements, and in doing so, qualifies for certain tax benefits.
What does that mean for you?
Having a qualified retirement plan like a 401(k) means you can potentially have a nice nest egg of funds tucked away for your retirement years. But remember these plans are designed for long-term savings, and as such, there can be early withdrawal penalties equal to 10% of the amount withdrawn before age 591/2.
The earnings are put into your investment account pre-tax, meaning the funds are not taxed until money is withdrawn, which typically happens after retirement.
While not all employers offer it, the Roth 401(k) is becoming a popular option for employers and employees alike. This version requires you to pay income tax on the contributions, but once paid, the money can be withdrawn with no further taxes paid on the contributions.
Is a 401(k) a defined contribution plan?
Yes, 401(k) plans are defined contribution plans where you and your employer can both contribute.
While some plans set the amount of employee contribution, employees typically get to decide how much they’d like to put towards retirement. There are contribution limits (currently $19,500 per year if 49 years old or younger and up to $25,500 if 50 or older in 2020).
Can you have two 401(k) plans?
There is also the question on 401(k) contributions limits and whether you contribute to a Roth 401(k) and a traditional 401(k) at the same time.
Theoretically, you can have and contribute to as many 401(k) plans as you want – just as long as you don’t exceed the maximum contributions limit.
As you advance in your career, you can take your money with you. If you leave your job for another opportunity, you can and should consider taking your 401(k) with you. You can do this by either moving it to your new employer’s plan or rolling it into a rollover IRA account – either way, we believe you should continue to keep your hard-earned money saving for retirement.
Are there any risks or downsides to 401(k) plans?
Any financial advisor who told you that ANY investment doesn’t come with a set of risks would be lying, and 401(k)s are no different.
401(k) plans rise and fall with the stock market, and therefore, are not protected from losses. That’s why it’s important to look at your risk level and diversify accordingly.
Not many people realize that 401(k) plans also come with fees, and depending on the investment company and the type of account you have, those fees may range anywhere from 0.5% to 3%.
Let McClellan Wealth Management Help with Your Retirement Planning
Saving for retirement doesn’t have to be intimidating. Consult with a member of our team to help set you up for your best future. McClellan Wealth management is here to help you through every phase.
Questions about securing your future? We’re here for you!
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. Advisory services offered through McClellan Wealth Management, a Member of Advisory Services Network, LLC.