It’s Your Money and You Need It Now
We consistently receive questions regarding employer-provided retirement accounts. If it feels like there are constant changes to the laws regarding contribution amounts and specific rules, you’re not alone. Today, we are going to talk about the defined contribution plan that most of you have heard of – The 401k. Other variations exist like a 403B, depending on your employer.
So, what exactly is a 401K? A 401k is an employer-sponsored retirement account. An employee can decide on an amount or percentage they would like to contribute to their 401k. This can either be pre-tax or post-tax (a.k.a. Roth, if your employer offers this option). It does not guarantee a specific payment at retirement and the employee takes on investment risk; which is the opposite of a defined benefit or pension plan. A defined benefit or pension plan allows an employee to select a withdrawal rate at retirement.
If you decide to contribute pre-tax to your 401k, your contribution will be deducted from your payroll and no taxes will be owed on this, for now. This can be beneficial in the year of the contribution, but you will owe taxes on contributions and earnings when you take withdraws later on. An employee may also choose to participate in a Roth 401K. This employer sponsored plan is a traditional 401K plan but with a twist. A Roth 401k essentially grows tax free. Contributions are made with after-tax dollars and earnings accrued within the account are not taxed in retirement.
Now that we know our options in our 401k, lets discuss matching and vesting. Matching is a certain percentage decided by the employer in which they contribute to your 401K in addition to your contributions. For example, let’s say your employer offers a 3% match. This means they will contribute 3% of your pre-tax salary to your 401K. It is essentially free money and a great way to grow your retirement account.
Another term to keep in mind when discussing employer retirement plans is the term known as “Vesting”. Many companies require employees to work a certain period before the contribution matches are fully granted to the employee. If you leave a company before a certain period, you might only receive a percentage of the amount contributed by your employer. The money YOU contribute is 100% yours and you are able to roll this into another 401k or IRA if you change employers. In 2023, the max an employee can contribute is $22,500 ($30,000 if you’re 50 or older). Catch-up contributions allow participants 50 years and older to make an additional contribution of $7,500 to their 401K plan.
With the passing of the new secure act 2.0, you might not be aware of the changes that were made and how they might impact you. A great example of one of the new changes is that after December 31, 2024, employers that offer 401k plans, have 10 or more employees, and have been in existence for 3 years, must provide automatic enrollment for new employees.
If reading congressional bills like the “Secure Act 2.0” isn’t your idea of a fun read, don’t worry because BCR has done it for you. Make sure to follow BCR on Facebook and LinkedIn to stay up to date with our upcoming series of blog posts covering all things Secure Act 2.0, and how it will affect your 401k!
Sources: https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview