"Saving for your future self is an important part of financial wellness. One of the cornerstones of that effort can be your employer-offered 401k. Still sketchy on the details of how they work and how to get started? We’ve got you covered.
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Give Me the 401k Basics
A 401k is a type of investment account offered through your employer that allows you to invest and save toward retirement using your current pre-tax income. You can invest a certain part of your salary every year, up to a minimum defined by the federal government. For 2020, this amount is $19,500. When you hear your friend say she is “maxing out” her 401k, she means she is saving that maximum amount every year. Bonus: that also reduces your taxable income, meaning your personal income tax is calculated off of your gross salary, less your 401k contributions.
As an important reminder, 401k accounts are not savings accounts. They are investments, and in investments, nothing is guaranteed. You can lose money, up to and including the amount you’ve originally invested. Because of that, it’s important to have your holistic savings plan mapped out in concert with any investment plans.
How Do I Get One?
You can work through your employer to open a 401k account. It’s most common to do this when you join a new workplace. But you can usually do so without any particular restrictions anytime.
What is My Money Invested In?
Your company usually will offer you a few different mutual fund and fund plans that are products offered by asset managers. These funds are often tailored to your expected retirement horizon, and your employer may even “default” the selection to one that they think matches what you might need. Sometimes, the number of options in this space can be overwhelming. But they don’t need to be. Your employer might offer a related financial advisory service, and some of your HR and benefits professors can help point you to resources to understand the account differences.
What’s a 401k Match?
Your company might offer a 401k “match,” meaning that they’ll contribute some sum of money toward your account, as long as you’re doing the saving first. For example, your benefits might explain that the company has a 50 percent match up to 5 percent of your salary. This means they’ll match half of what you contribute, but only up until that dollar amount hits 5 percent of your salary. They might also explain the benefit as matching “50 cents on the dollar” for every dollar you contribute up to a set amount.
If you’re a gal working toward maxing out her 401k options, it’s really helpful to know exactly how much your employer will match and what that limit is. (You’d find this out by searching your HR website or reaching out to your benefits HR partner for your division.)
Also, your personal own contribution is the only thing that the IRS limits. So, don’t worry that your employer contribution will “push you over” any maximum savings. Instead, it’s really free money! It’s a great financial goal to be saving enough in your 401k to maximize your company’s employee 401k match.
And I Get to Keep All That Money?
Well, eventually. Your employer probably has a “vesting” program in place. That means that the portion that they match for you becomes yours after a defined period of time. That usually looks like a certain percentage every year, and then after a few years, 100 percent of that match money is yours. That’s a rolling program, and basically, the company is using it as an incentive to keep your fabulous self at the company longer.
That said, if you leave your job before your match vests, it’s only the “unvested” portion you’re leaving on the table. The contributions you make are always yours to keep.
I’m Thinking of a Job Change. How Do I Handle My 401k?
Your money goes with you! If you’re headed to a new job, it’s important to try and find the right fit to “rollover” your 401k to a program offered by your new employer instead of straight-up cashing it out. If you cash out, you put yourself in a tough spot. You’ll not only pay taxes on all that money, but you’ll also pay a 10 percent penalty for early withdrawal. You’ll also be working against one of our favorite financial principles: the time value of money. Taking a big chunk of investment out of the market misses the opportunity to let that grow over time.
OK, But I Actually Have a Pretty Important Life Event I Could Use that Money For…
Heard girl. And the IRS hears you too. There are certain instances, both from a regulatory point or from a personal need where it might make sense. But these are few and far between, and pulling from this type of account is never your best first (or even second) financial option.
Before you go straight up withdrawal, you might want to think about a loan. If your financial need is medical, or you’ve been out of work for a certain period of time, you may be able to withdraw money without a penalty. You might also be able to withdraw money for certain funeral or education expenses. Again, it’s important to understand the rules around these withdrawals and how they impact your investment goals over the long term.
So, How Do I Get This Money Down the Road?
The rules for distribution in your 401k plan will vary but likely revolve around a couple of events. You could start taking money as early as age 59.5. The IRS actually mandates that you start taking what they call “minimum” distributions by age 70.5 unless you are still employed. That means you’ll start paying taxes on the gains and distributions you’re taking.
A 401k account could be a good way to kickstart your retirement investing! If you’re not already thinking about how to save for your retirement, starting with what your employer offers through their 401k programs is a great place to start.