Explaining 401k Retirement Accounts

A 401k retirement savings plan is a type of workplace benefit that allows employees to contribute to their accounts. It provides them with a tax break on the money they save. The annual contribution limit for a standard 401k is $20,500 in 2022. For those over 50, the limit is $27,000.

The term “401k” comes from a section of the tax code that governs this type of plan. It allows employees to automatically deduct their contributions from their pay. Depending on the type of plan they have, the tax break can be used when they withdraw their money or when they contribute.

If you’re like most people, you probably dozed off during employee orientation, you might’ve missed some of the best features of these plans. However, there’s a lot more to this type of benefit than you might assume.

Where You Get a 401k

401ks are available through employers. Unfortunately, not every company offers a 401k. If you’re one of those people, you might want to consider getting an individual retirement account (IRA) instead. This type of plan provides the same tax benefits as a 401k. An IRA is a type of retirement account that typically has lower fees and a wider selection of investments. However, it also comes with a few drawbacks, so do your research.

Why It’s Worth It

Most companies offer to match a portion of an employee’s contribution. This is typically a dollar-for-dollar match, which means that if you contribute a certain amount, your company will give you a portion of that money. How much they will contribute varies drastically depending on your employer and how much you make, but it’s generally a certain percentage of your annual salary. If you don’t contribute enough, you won’t maximize the benefits. Plan to at least invest enough in your 401k each year to maximize your employer’s matching contribution.

There are two main types of 401k retirement accounts: the traditional and the Roth. The former provides an upfront tax break, while the latter allows employees to make contributions with after-tax dollars. Although the Roth doesn’t provide the same tax break as a traditional account, it does come with a payoff.

Roth vs. Traditional Accounts

Before taxes are taken out of your paycheck, contributions to a traditional 401k account are taken out of your paycheck, which allows you to save a little more money. For instance, if you’re contributing $200 a month to a traditional 401k, you’ll save $200 after taxes are taken out. Aside from boosting your savings, pretax contributions to a 401k can also lower your income taxes. For instance, if you make $65,000 a year and contribute $19,500 to your 401k, you’ll only pay taxes on $45,500 of your income. The tax advantages of a 401k account are built into its structure, which means that no taxes are paid on the money that’s in it. This means that even if the investment grows, you won’t pay taxes on it.

Unfortunately, the tax advantages of a traditional 401k account won’t last forever. Eventually, the IRS will take a cut of the money that you’ve contributed. This means that even though you’re contributing to the account, you’ll still have to start paying taxes on it when you start making withdrawals.

A Roth 401k eliminates this issue completely. Unlike a traditional 401k, a Roth account doesn’t have to pay taxes on the money that you put into it. This means that you don’t have to worry about paying taxes on the money that you withdraw.

401ks Are Transferable

If you’re leaving your job, make sure you take your 401k with you! It’s often a great idea to convert it to an individual retirement account (IRA). This will allow you to keep the money in the account and avoid having to move it to a new account. However, rolling it over into a new 401k through your new job is also an option! Just keep in mind that many companies’ contributions won’t carry over if you only worked there for a short time.