401(k) Plans – Understanding the Basics
Our quick primer on this retirement savings vehicle, whatever your age.
If maximizing your retirement savings is a priority, and you’re looking for a little motivation to establish and/or get more involved in your 401(k) plan no matter what your current age, consider these findings from a recent Wall Street Journal report entitled “The Unprepared––A Generation of Americans is Entering Old Age the Least Prepared in Decades”.
“Unprepared”, Geoffrey Rogow, WSJ, August 7, 2018
“More than 40% of households led by people aged 55 through 70 lack sufficient resources to maintain their living standards” in retirement.”
“Households with 401(k) investments and at least one worker aged 55 through 64 had a median $135,000 in tax-advantaged retirement accounts as of 2016, according to the latest calculations from Boston College’s center. For a couple aged 62 and 65 who retire today, that would produce about $600/month in annuity income for life, the center says.”
The why behind 401(k) plans
In 1978, the United States Congress authorized a tax-law change that ushered in 401(k) plans, retirement savings vehicles provided/sponsored by employers. Such plans allow employees to reduce their taxable income by placing their own pre-tax dollars in a 401(k) account (aka a “defined-contribution account”). The goal then and now has been to encourage and help people build their retirement funds. A dual goal back in the late 1970s was to supplement the pension payouts employees often received in those days. Since then, however, many companies with their pension funding squeezed by economic cycles and recessionary periods over the years have limited pensions or replaced them altogether with 401(k) plans.
How 401(k) plans work
• Employees who put money in a 401(k) can deduct their contributions from their taxes. Their 401(k) contributions are invested and grow tax-free until retirement, at which time retirees pay taxes on withdrawals from their 401(k). Current legislation requires that retirees start taking mandatory distributions from retirement accounts once they turn 70-1/2 years of age.
• Employees decide what percentage of their pay they want to contribute. The designated amount is deducted from the employee’s paycheck and automatically placed in their individual 401(k).
• Employees are capped at how much they can put in a 401k annually –– either up to earnings or $18,500. If you are over age 50, you have a catch-up option of up to an additional $6,000 contribution per year.
• A 401(k) plan is portable meaning that when changing jobs, employees maintain ownership of their account and can move it from one company to another without penalty. They can roll from 401k to 401k – or to an IRA with no penalties.
• In 401(k) plans, employees are allowed to choose their own investments from a limited selection (typically mutual funds) offered by their employer and overseen by an independent plan administrator. While the employer will offer information on the funds, the onus is on the employee to decide which is best for them. Selecting one’s own stocks can make a 401(k) somewhat of a DIY retirement plan. This has worked well for some people and not so well for others. Like any investment, there is risk involved and losses can occur. For example, many people lost a significant portion of their 401(k) in the 2007-2009 recession, and/or they cashed out or borrowed from their 401(k) savings to cover other expenses, funds they have not been able to replace.
• Monies withdrawn from a 401(k) before the account owner is age 59-1/2 typically results in the employee paying a10% early withdrawal penalty on top of any taxes due.
• Many employers offer to match employee contributions –- typically up to a percentage one’s annual salary. It is wise to take advantage of “matching programs”.
What is a Roth 401(k)?
A Roth 401(k) is a type of 401(k) offering tax savings that is essentially the reverse of a traditional 401(k). Employees pay tax on their 401(k) contributions at the time the contributions are made, but they do not have to pay any tax in retirement when they withdraw their savings. As such, all money in their 401(k) account grows tax-free.
Making 401(k) plans more accessible
Because it is not mandatory for employers to offer employees a 401(k), Congress in 2006 enacted legislation to help private-sector workers without workplace 401(k) plans enroll in a 401(k) via state-run-retirement-savings programs.
Currently, an executive order is being considered by President Trump that would make it easier for small businesses to offer employees 401(k) plans. The idea is for small businesses to band together in order to share the overhead costs of 401(k) plans and, thus, have the economies of scale that larger companies enjoy.
Learn all you can about 401(k) plans
We’ve given you some 401(k) highlights, but we encourage you to learn or refresh yourself on the specifics of your 401(k). Let us know how we can help. Lenox professionals are here to explain 401(k) fundamentals and to help guide you in your 401(k) plan investment options. Give us a call at 513-618-7080.
At Lenox, we work with families to help guide them in every aspect of their financial life –– from education funding, to generational planning and finances, to setting financial priorities, to eliminating debt, establishing budgets, career planning and coaching, retirement planning, and working through financial hurdles –– the entire realm of wealth creation, wealth building, and wealth management. In every instance, we start with you, not your portfolio to help you FUND A LIFE YOU LOVE™.
If you’re ready to discuss financial, business, career and life planning that will allow you to Fund a Life You Love®, we’d love to tell you more. Let’s talk. It’s your tomorrow. Call us for a complimentary 1-hour review. Call 513.618.7080 or visit www.lenoxwealth.com to Fund a Life You Love.
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