Question: What 401k rules should I be aware of?
Answer: Fortunately, the rules for 401k accounts are fairly simple, yet you do need to understand the ins and outs of managing your account.
The good news is that saving for retirement is a task made much easier with a 401k. The best 401k advice that we can offer is for you to get familiar with the 401k rules that apply to your employer’s specific plan.
"Who recalls when folks got along without something
if it cost too much?”
- Kin Hubbard |
Each 401k plan is a little different and may require you to make some adjustments to your retirement savings strategy from time to time.
A 401k savings plan allows you to make contributions from your paycheck into a retirement savings account. These funds accumulate and are invested, hopefully earning interest, on a pre-tax basis. In other words, you will not be taxed on these funds until you begin to withdraw the money at the age of retirement.
Most 401k programs are established by an employer as a benefit for its employees. Many companies even offer to match a certain percentage of the employee’s contributions to his account, helping the balance to accrue that much faster.
There are some basic 401k rules that govern these accounts and how they operate. However, each plan can vary slightly based on the choices made by the employer, as well as the changing tax code. Your employer will be able to tell you specifically what rules govern your plan.
In addition, there are some general 401k tips and principles to understand regarding contributions, investments, matching funds and withdrawals. For instance, employees are allowed to contribute a percentage of their income into their 401k account. Contributions must be made by an automatic payroll deduction and are taken out before taxes are applied to the remaining income.
There are also limits to how large that percentage of the contribution can be. The limit may differ depending on your income or even your age.
Your employer may provide multiple options for how your 401k funds are invested. They can often choose between a variety of low, medium and high-risk investment funds. However, there are some companies that have chosen to direct their 401k plan without employee input.
Many companies will match the funds you contribute each year up to the first 3-6%. Your employer may have set up a vesting schedule, based on years of employment, which affects when the matching funds are permanently a part of your account balance.
You should always read the plan materials you received when you enrolled to see what the 401k rules at your company require regarding vesting of matching funds.
Another great source of information on savings is our free tool, Fiscal Fitness for Older Americans. In addition, we provide a full menu of free online calculators.
401k withdrawals are of particular importance, and concern. There are very strict 401k rules regarding early withdrawals and/or borrowing from 401k accounts. If you take funds out of your account before you have reached retirement age, you will have to pay the taxes on the amount withdrawn plus a sizeable 10% fee.
This can put a serious dent in the account you’ve worked so hard to grow for your retirement years. Likewise, loans against the balance in your account are a very bad idea. If you happen to lose your job for any reason, you will have to pay back the loan against your 401k within 90 days or face serious penalties.
Avoid making these two major mistakes! If necessary, manage your 401k with some help from your employer’s representative, your CPA or investment representative.
Be sure to have a good working knowledge of the rules that regulate your plan so you can use this popular saving tool to its greatest advantage.
"One way to solve the traffic problems of this country
is to pass a law that only paid-for cars
be allowed to use the highways.”
- Will Rogers |
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Debt is NOT your friend. It's not a wonderful "tool" for building wealth. That's a myth.
