401(k) Definition: An Overview of How it Works

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(Newswire.net — September 7, 2021) —

Retirement is something everyone looks forward to. Who doesn’t want to spend more time doing the things they love?

But in order to do that, you need to be able to fund your retirement.

One aspect of your retirement funding could come from your 401k. 401k plans can be great retirement plans. Unfortunately, many people don’t understand what a 401k is. 

Keep reading to find out the 401k definition, as well as an overview of how it works.

The 401k Definition

A 401k plan is a retirement savings plan offered by many employers in the U.S. When an employee signs up for a 401k plan, a portion of each paycheck pays into an investment account. Usually, this is a percentage of their total pay.

As an incentive to contribute, many employers offer employer-sponsored plans. They match an employee’s contribution to the plan, up to a set percentage. For example, a three percent match means that an employer would match up to 3% of the employee’s contribution from each paycheck.

An employee can always contribute more than the match, it just won’t be matched by their employer.

These contributed funds are then invested in a range of assets such as cash, stocks, bonds, and mutual funds. Of course, if you want your investments to go further, you can consult experts who will help you with trading, such as kjtradingsystems.com.

Types of 401K

There are two basic 401k types: traditional and Roth. Both plans are different in how they are taxed.

With a traditional 401k, the employee’s contributions are not taxed until they begin to withdraw from their 401k fund, which is usually when they retire. As a result, their taxable income is reduced during the contribution year.

With a Roth 401k, the funds withdrawn during retirement are tax-free. That’s because the funds are deducted from after-tax income during the contribution year. 

Ultimately, what type of 401k you want is up to you, so you should consider the differences and decide where to put your money.

401k Contribution Limits and Deadlines

401k employee contribution limits depend on your age. For workers under 50 years of age, the annual contribution limit is $19,500. Workers over 50 are allowed a “catch up” contribution of $6500, making their annual contribution limit $26,000.

The contribution deadline ends at the end of the calendar year. However, the IRS allows contributions up to the filing deadline of the next year. For the 2021 tax year, your last day of possible contributions is April 15, 2022.

401k Withdrawals

Regardless of the type of 401k plan you have, you usually have to be 59 and a half years old before withdrawing money. Otherwise, you will face a 10 percent early distribution tax, on top of any other tax you may owe. 

However, there are exceptions. If you are totally disabled, you can withdraw funds early without penalty.

Generally speaking, you don’t want to withdraw from your 401k early. 

Once you reach 70 years old (or 72 if your birthday is July 1, 2019, or later) you must take the RMD, or required minimum distribution, each year. However, this only applies to traditional 401k plans, not Roth 401k plans.

It’s Time to Get Started

Now that you know what the 401k definition is and how they work, you can start funding your retirement.

If you haven’t signed up for one yet, you need to. And if you are already contributing to a plan, consider upping your contribution. If you aren’t sure what to contribute, check out a 401k calculator

For more financial news and advice, check out the other articles in our Finance section.

 

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