If you plan to retire someday, a 401(k) plan may be on your radar. 401(k)s can help you save retirement money to help you enjoy your golden years financially secure. Here are some facts about the 401(k) to help you get started on your retirement journey:
The History of the 401(k)
In the Revenue Act of 1978, a “Section 401(k)” allowed employees to avoid paying taxes on deferred compensation. In 1980, a benefits consultant named Ted Benna was looking for a tax-friendly retirement program for one of his clients.
He referred to Section 401k and decided it was a good idea for employees to contribute pre-tax money into a retirement plan while earning an employer match. Even though Benna’s client didn’t follow through with his idea, Benna incorporated the idea into his own company, The Johnson Companies. In 1981, the IRS started allowing employees to fund their 401(k)s through payroll deductions, and the rest is history.
How a 401(k) Works
If your employer offers a 401(k) plan, you may choose to enroll as long as you meet the eligibility requirements. Before you contribute to a 401(k), you’ll need to determine whether you want a Traditional 401(k) or Roth 401(k) and decide how much you want to save. Here’s how each type of 401(k) works:
Traditional 401(k): Contributions are made with pre-tax dollars with a Traditional 401(k). Your contributions will help reduce your income tax by offsetting income. With pre-tax contributions, you won't pay taxes on the money you contribute or your investment's growth until you withdraw from your investment account. When you retire, the funds are taxed as regular income.
Roth 401(k): If you contribute to a Roth 401(k), your contributions are made with after-tax dollars. Your contributions will grow tax-free, and you won’t be responsible for paying taxes on the contributions or accumulation inside the account on withdrawals during retirement.
How to Contribute to a 401(k)
You have the freedom to choose how much you contribute to your 401(k). However, remember that the IRS sets maximum contributions every year. For 2023, the maximum is $22,500 if you’re under 50. If you’re 50 and over, you can contribute $7,500 more or $30,000. If you have a 401(k), you can contribute to it, no matter your age.
There is also an overall contribution limit, combining employee and employer contributions. This limit is between $66,000 and $73,000 for employees 50 and older. Keep in mind that employer contributions are limited to 25% of the employee’s salary.
With the passing of the SECURE Act 2.0, if employers have a 401k plan, they are required to offer the plan to all employees at least 21 years old that have 1,000 hours of service a year or three consecutive years with 500 hours of service. Employees under the age of 21 are permitted to have a 401(k) plan offered by the employer. However, employers are not obligated to by law. Retirement plans are based on employment, and labor laws can restrict when you can get one. Financial guidance can help you navigate these potentially complex rules and regulations.
How much can you contribute? It all depends on how much you can afford, how much you want to save for retirement, and how much you may need in retirement. Your financial professional can help you determine all of these factors. Contribute enough to meet your employer match so you don’t miss out on “free money.”
After you decide how much you want to contribute, set up a payroll deduction with your HR department or 401(k) custodian. A certain amount will be deducted each time you get paid and go directly into your 401(k) account. Your human resources department can guide you through this process.
Consult Your Financial Professional
Your financial professional can help you determine a 401(k) plan for your unique lifestyle and retirement goals.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This material was created for educational and informational purposes only and is not intended as ERISA or investment advice. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by Fresh Finance.
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