401(k) Plans: Key Considerations

What Is a 401(k) Plan?

A 401(k) plan is a retirement savings plan sponsored by an employer. It lets workers save and invest for their own retirement. The plan is named after the section of the Internal Revenue Code that created it.

401(k) plans are available through many employers, including private companies, non-profit organizations, and government agencies. Employees can typically elect to have a portion of their paychecks deposited into their 401(k) plan accounts. 401(k) plans may also offer other investment options, such as stock in the company, mutual funds, and bonds.

401(k) plans are one type of defined contribution plan. Other types of defined contribution plans include 403(b) plans for employees of public schools and certain tax-exempt organizations, and 457 plans for state and local government employees.

401(k) plans are subject to certain rules and regulations set by the Internal Revenue Service (IRS). For example, there are limits on how much money employees can contribute to their 401(k) plans each year.

Contributing to a 401(k) Plan

401(k) plans are designed to encourage employees to save for retirement by offering them tax breaks. 401(k) plans are tax-deferred, meaning that employees do not have to pay taxes on the money they contribute to the plan until they withdraw it. 401(k) plans may also offer matching contributions from employers.

Contribution Limits

401(k) plans have annual contribution limits. For 2021, the limit is $19,500 for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Employees who are age 50 or older can make catch-up contributions of up to $6,500, for a total contribution of $26,000.

401(k) Plan Withdrawals

401(k) plan withdrawals are subject to income taxes. Withdrawals made before age 59½ may also be subject to a 10% early withdrawal penalty. Employees who leave their jobs may be able to take their 401(k) savings with them, but there may be tax consequences if they do so.

401(k) Loan

Employees who participate in 401(k) plans may be able to borrow money from their accounts. The loan must be repaid with interest, and there are restrictions on how much can be borrowed. 401(k) loans are generally limited to $50,000 or half the value of the account, whichever is less. 401(k) loans must be repaid within five years unless the loan is used to purchase a primary residence.

401(k) Hardship Withdrawals

Employees may be able to make hardship withdrawals from their 401(k) plans in certain cases, such as to pay for medical expenses or to prevent eviction from their homes. Hardship withdrawals are subject to income taxes, and they may also be subject to the 10% early withdrawal penalty if made before age 59½.

401(k) Plans and Retirement

401(k) plans can be a helpful tool for employees who are saving for retirement. However, 401(k)s are not the only way to save for retirement. Employees may also want to consider other options, such as Individual Retirement Accounts (IRAs) or Roth IRAs.

Employer Matching 401(k) Contributions

401(k) plans may offer employer matching contributions. Employer matching 401(k) contributions are made by the employer and matched to employee 401(k) contributions, up to a certain percentage of salary. For example, an employer might match 50% of employee 401(k) contributions, up to 6% of salary. Employer matching 401(k) contributions are subject to the same contribution limits as employee 401(k) contributions.

401(k) Rollover

Employees who leave their jobs may be able to roll over their 401(k) savings into a new employer’s 401(k) plan or an Individual Retirement Account (IRA). There are tax consequences if employees choose to roll over their 401(k) savings.

401(k) Withdrawals

401(k) withdrawals are subject to income taxes. Withdrawals made before age 59½ may also be subject to a 10% early withdrawal penalty. Employees who leave their jobs may be able to take their 401(k) savings with them, but there may be tax consequences if they do so.

401(k) Plans and Retirement

401(k) plans can be a helpful tool for employees who are saving for retirement. However, 401(k)s are not the only way to save for retirement. Employees may also want to consider other options, such as Individual Retirement Accounts (IRAs) or Roth IRAs.

401(k) Plan Withdrawals

401(k) plan withdrawals are subject to income taxes. Withdrawals made before age 59½ may also be subject to a 10% early withdrawal penalty. Employees who leave their jobs may be able to take their 401(k) savings with them, but there may be tax consequences if they do so.

Traditional 401(k) vs. Roth 401(k)

401(k) plans can be either traditional or Roth. Traditional 401(k)s are funded with pretax dollars, which reduces employees’ current taxes. Roth 401(k)s are funded with after-tax dollars, which means that employees will not owe taxes on the money when they withdraw it in retirement.

401(k) contribution limits

401(k) plans have contribution limits that are set by the IRS. For 2021, the 401(k) contribution limit is $19,500 for employees who are under age 50. Employees who are age 50 or older can make catch-up contributions of up to $6,500, for a total 401(k) contribution limit of $26,000. 401(k) contribution limits may be higher for employees who participate in 401(k) plans that have catch-up contributions.

Bottom Line

A 401(k) is a retirement savings plan that is sponsored by an employer. 401(k) plans have tax advantages and may offer employer matching contributions. Employees who leave their jobs may be able to roll over their 401(k) savings into a new employer’s 401(k) plan or an Individual Retirement Account (IRA). Withdrawals from 401(k) plans are subject to income taxes, and withdrawals made before age 59½ may also be subject to a 10% early withdrawal penalty.