A 401k is a popular type of retirement savings account. The 401 in the title refers to the IRS document that regulates the rules and limits. These plans work like this. Your employer offers a retirement saving fund that you sign up to participate in. Once you join the program, you will direct a predetermined amount of money from your bi-weekly paycheck and place it into your retirement fund account.
This money goes into your account before taxes are deducted which reduces the amount of money being taxed on that check i.e. If your check is $2000 and you commit 10% to your account plan then you will only be taxed on $1800 for that time period. A plan may allow employees who are age 50 or over to make additional contributions to their retirement account. If you are over 50 and your plan allows it, you can increase the amount you contribute up to $5,500 per year.
One important plus about these plans is company matching. This means the company matches a certain percentage of the contribution that you place into your account. Employer matching should be used if offered, as it adds free money to your retirement account at no further cost to you. An example: if you pledge 7% and your company offers 3% matching then you are adding 10% to your retirement account every pay period.
Some company’s plans require a vesting period. What that means is that you must remain with the company for the entire vesting period in order to get all the monies that they offer as a match. Usually this vesting is graduated, the longer you stay, the higher the percentage you get to keep of the matching funds..If you resign or join another company before completing the vesting period than you only receive the monies you have invested into your account or a percentage of the matching monies if they have a graduated program. Matching is one of the 401k rules you should take advantage of to maximize your retirement income.
The plan has rules and limits which determine how much you can invest and rollover (transfer money from other accounts to this one). The annual investing cap for these plans was $17,500 for 2014. One of the 401k rules is based on the age of the investor. A person over 50 is allowed to place an additional $5,500 catch-up money in their account each year. 401k rules dictate the age a person my withdraw their funds without incurring financial penalties.
Aside from 401k limits, you also must be informed of any 401k rollover rules. If you had a retirement plan with a company and you leave for another employer then you must be aware of any 401k rollover rules not only from your old plan but also any 401k limits in the new plan. There are two ways to rollover funds from one account to another:
- Direct rollover – A direct rollover from an eligible retirement plan to another eligible retirement plan is not taxable, regardless of the age of the participant.
- Indirect rollover – An Indirect rollover from an eligible retirement plan to another eligible retirement plan, but the funds are actually given to the employee via check to be deposited into the new account. The funds must be deposited into the new IRA within 60 days to avoid penalty.
The 401k rollover rules vary by company and plan structure so it would be best to consult the company’s HR department for 401k plan specifics.
Featured Image: Thinkstock/AndreyPopov