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Planning Your Future

The 5 Biggest Questions About 401(k)'s

5 Straightforward Answers to Your Top 401(k) Questions

Starting your financial planning, particularly for retirement, may feel like diving into a bowl of alphabet soup with IRAs, Roth IRAs and SEPs. One of the most popular and powerful retirement vehicles, though, sports a more numerical name: the 401(k).

Set up by employers, these plans allow employees to contribute a portion of their wages to retirement accounts and lower their taxable income at the same time. One of the greatest appeals of these accounts is that some employers match employee contributions.

One big draw of 401(k)s is their ease of use. There are some aspects of them, though, that may need clarifying. Here are five common questions related to these accounts:

1. Is it okay to withdraw from my 401(k)—especially for buying a home?

The idea behind a 401(k) account is that you're putting away money for retirement without paying tax on it up front. So there are limits on when and how you can use the money before you retire.

There are ways to make early withdrawals or take a loan from your own account, but generally, it's not a good idea to borrow or withdraw from your 401(k), according to Kate Stalter, founder of investment advisory firm Better Money Decisions.

There can be penalties for early withdrawals, but some are reduced or eliminated if you're using the money to buy a home or for financial hardships such as medical bills, but the rules can be complex and it's best to talk to your employer and a tax adviser before making a move.

2. Will my employer match my contribution?

Talk to your HR department about 401(k) matches to make sure you fully understand what, if anything, is offered. Matching means that the company will contribute money into your 401(k), but different employers have different ways of calculating their match amount.

For instance, in one scenario, an employer might match 50 percent of employee contributions, up to the first 6 percent of salary. If an employee in that scenario puts only 3 percent of every paycheck into a 401(k), he or she might miss out on another 3 percent in employee matching funds.

Another consideration is length of employment. For example, at news and advocacy organization ConsumerAffairs, employees who have been with the company more than five years will get the maximum match amount, says Jared McDonald, the company's talent and culture manager. Those who have been at the company under five years get a smaller percentage of matching funds. McDonald says this is an effective retention tool, and simply offering the 401(k) options helps to draw job candidates.

3. How much should I contribute?

The traditional advice is to contribute as much as you can, especially if you can take full advantage of an employer match.

This, Stalter says, is "well-intentioned insight, and mathematically sound." But, she notes, this "often doesn't jive with reality. People have bills, student loans, rent or mortgage, and all the other expenses that go with daily life."

To make 401(k) contributions less intimidating, Stalter recommends starting with just a 1 percent to 2 percent paycheck contribution and increasing the percentage over time. Consider edging it up just a bit every year.

4. What should I do with my 401(k) when I switch jobs?

This can be a good time to make a direct rollover from an employer's plan into an Individual Retirement Account (IRA). If the money goes directly from one to the other, there are often no tax consequences. You may also have the option to roll the funds into your new employer's 401(k). Again, it's good to talk to your old and new employers and a tax adviser to make sure you fully understand the options.

5. How should I allocate my 401(k)?

When you have money in a 401(k) plan, your employer may provide a number of different ways to invest it. If you're not an investment whiz, the best method of allocating your funds is to have a good understanding of what kind of return you need to generate, given your time horizon and your tolerance for risk, Stalter says. To help you gauge all this, you may want to hire a financial planner, she says—even just for one-time help answering these questions. Ultimately, though, you may want to enlist an adviser for ongoing assistance, since you may need to rebalance your account from time to time.

In general, 401(k) plans can be very helpful opportunities for building retirement savings, especially if your employer offers matches. At ConsumerAffairs, the organization has a particular way to get employees to participate. Says McDonald, "We tell them, 'If you hate free money, don't participate in the 401(k).'"

The information expressed is being provided for informational and educational purposes only. It does not intend to provide specific advice or recommendations for any individual and should not be relied on for accounting, legal, financial or tax advice. You should carefully consider your needs and objectives before making any decisions. For specific guidance on how this information can be applied to your situation, you should consult your financial, accounting, legal or other advisors.

For more tips and resources on mastering your finances, visit chase.com/financialfitness.

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