5 answers to your 401(k) questions
Editorial staff, J.P. Morgan Wealth Management
- A traditional 401(k) salary deferral is a type of retirement plan contribution available within 401(k) plans that allows eligible employees to contribute a percentage of their paycheck on a pretax basis (up to an annual limit determined by the IRS) to save for retirement. Once in the account, any growth to the money in your 401(k) is tax-deferred; this means you don’t pay any taxes on your investments until you start withdrawing money.
- A Roth 401(k) salary deferral – another feature available in most group 401(k) plans – allows you to contribute after-tax money from your paycheck. Your contributions have the potential to grow tax-free over time, and you won’t have to pay taxes on withdrawals, as long as they are “qualified distributions” or a return of your regular annual contributions.
- If your employer offers matching contributions, you may want to contribute enough to get the match.
401(k)s are one of the most popular types of employer-sponsored savings plans in America. There are two types of 401(k) employee contributions: traditional and Roth. While both of these contribution types may be available in your 401(k) plan, it's important to know that different plans may have different terms and conditions, so you may want to check with your plan representative on the rules that apply to you.
A traditional 401(k) salary deferral is a type of retirement plan contribution available within 401(k) plans that allows eligible employees to contribute a percentage of their paycheck on a pretax basis to save for retirement. Once in the account, any growth to the money in your 401(k) is tax-deferred; this means you don’t pay federal income taxes on your investments until you start withdrawing money.
A Roth 401(k) salary deferral lets you contribute money from your paycheck with after-tax dollars. Your contributions have the potential to grow tax-free over time, and you won’t have to pay taxes on withdrawals, as long as they are “qualified distributions.”
If your 401(k) plan offers both contribution types, it’s great to have options. You can contribute to your plan just as a pretax salary deferral, just as Roth salary deferral or both. However, it is important to know that the annual limit for 401(k) employee contributions is aggregated, meaning that there is one overall limit for both contribution types.
One major potential benefit of 401(k) plans is that your employer can make matching contributions. This can allow you to jumpstart investing for retirement.
Here are five things you should know about 401(k) plans:
Here are the answers to some common questions about 401(k)s.
1. How much should I contribute to my 401(k)?
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The typical advice is to contribute as much as you can when you can, but if your employer offers a match, then consider contributing at least enough to meet it. You can think of matching dollars as free money – and you don’t want to leave any on the table. Industry experts generally recommend contributing at least 15% of your annual income (before taxes), which can include an employer match, up to the annual IRS limits.
You can start small and add from there, aiming to put away a higher percentage of your salary over time.
2. What is a 401(k) match?
Matching means that the company you work for may contribute money to your 401(k) up to a certain point. Talk to your employer about whether there’s a match, and, if so, how it works. If offered, consider contributing enough to meet it.
3. How do I choose the investments in my 401(k)?
When you have money in a 401(k), your employer may provide a number of different ways to invest it.
If you’re looking for more of a hands-off approach, many 401(k) plans offer target date funds. Target date funds are mutual funds that can be aligned with the year you think you’ll retire. The funds reallocate your assets over time to help get you there.
If you prefer more of a do-it-yourself approach, then you can typically choose from a list of funds to build your own investment mix, taking into account your risk tolerance, investment objectives and time horizon.
4. Can I withdraw money from my 401(k) whenever I want?
No. The idea behind a 401(k) is that you’re putting away money for retirement, so it’s recommended that you start saving early and leave the funds untouched until then. You are only allowed to withdraw money according to the rules of your plan and the IRS, and you will be subject to taxes at that point in accordance with the applicable rules. Depending on whether you qualify for an exception, you may also face an early withdrawal penalty. If you’re strongly considering withdrawing from your 401(k), be sure to speak with a tax professional first.
Also note that, once you hit a certain age, you may be required to withdraw money annually according to the IRS rules on required minimum distributions (RMDs).
5. What should I do with my 401(k) when I change jobs?
Deciding what to do with your 401(k) assets could be one of the most important financial decisions you make when changing jobs. You may be able to:
- Stay in your former employer’s plan
- Roll over to your new employer’s plan
- Roll over to an Individual Retirement Account (IRA)
- Take a lump-sum distribution (both income taxes and the early distribution penalty tax may apply)
No matter what move you make, it’s important to discuss your situation with a tax professional first.
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Editorial staff, J.P. Morgan Wealth Management
