There is a good chance that you’ve heard about 401(k) plans, whether you’ve heard your parents talk about theirs, or you’ve been offered one through an employer. If you find yourself in the event of the latter, then you’re probably wanting to learn a little bit more about them before signing up for one.
Here’s everything you need to know about an employer-sponsored retirement savings plan, aka a 401(k).
Unlike other retirement savings plans, 401(k) plans have certain qualifications that must be met in order to open one. First and foremost, since it is an employer-sponsored plan, you must work for an employer who has established a 401(k) plan.
Alternatively, if you are self-employed you can set one up that way as well, in which case you would be qualified as the employer and employee. Other qualifications may include being at least 21 years of age or having at least one year of service, but those qualifications are set by the employer and are subject to change.
Contributing to a traditional 401(k) is simple and doesn’t require a lot of work on your end. When setting up your 401(k), you decide how much you want to contribute each month, and that amount is deducted before taxes from your paycheck.
The money deducted from your paycheck is then transferred into your 401(k) account and invested. When setting up your plan, you have different options when it comes to how you want to invest your money – through stocks, bonds, or mutual funds.
There are some restrictions on how much you can contribute, however. For instance, in 2020 the maximum contribution limit is $19,500 unless you are 50 years of age or older, in which case you could contribute $6,500 in catch-up contributions. Limits change from year to year, so make sure you stay up to date as they change.
Perhaps one of the best benefits of investing in a retirement savings plan is the tax benefits. Since contributions to traditional 401(k) plans are made pre-tax, they reduce your taxable income and the taxes you’ll pay for the year.
Your income also affects the amount of tax savings you receive, as having a higher income will put you in a higher tax bracket. Generally speaking, the more money you make, the more of an incentive it is for you to contribute to your 401(k) since you will save more in taxes by contributing. It should be noted however that contributing to a 401(k) regardless of your income level will still help you save money on taxes.
Do be mindful though that you will have to pay taxes on your 401(k) eventually. Once you decide to withdraw from your 401(k), you must pay income tax upon withdrawal at whatever the current tax rate is at that time.
While there is a lot to know about 401(k) plans, this rundown of a traditional 401(k) should be a good starting point for you if you’re planning to open one. If your employer doesn’t offer one, have them reach out to SaveDay to talk to us about establishing a small business 401(k) plan today.
Photo by Bruce Mars on Unsplash.