A beginner’s guide to 401(k) plans

Individuals 07.21.2022 4 MIN

As Open Enrollment rolls around, we put together some information on 401(k)s to help you maximize the value of this benefit offered by your employer.

The basics

A 401(k) plan is a type of workplace retirement account that many employers include in their benefits package.
Once you’ve signed up for a 401(k), you can tell your employer to take a percentage of your paycheck and put that money into your 401(k) account where it will then be invested.
401(k)s are considered tax-advantaged investment accounts that may offer potential tax benefits.

How does a 401(k) work?

There are several types of 401(k) plans that employers may offer. We’ll focus on the two most common plans that you’re likely to come across at work: a traditional 401(k) and Roth 401(k).

Traditional and Roth plans share many features. Both allow you to contribute a portion of each paycheck to be invested, letting it potentially grow over time in your 401(k) account. A key difference is how these accounts are taxed.

With a traditional 401(k), you contribute pre-tax dollars—money taken out before income taxes—through automatic payroll deductions. Those pre-tax dollars are then put into your 401(k) where the money can grow tax-deferred. This means you won’t need to pay taxes on your contributions and potential earnings until you take the money out. However, you may be subject to an early withdrawal penalty if you use the funds before the age of 59 ½.

For a Roth 401(k), you contribute to your account with after-tax dollars—money taken out after income taxes. Generally, if you’ve had the account for five or more years, withdrawals from your Roth 401(k) are tax-free starting at the age of 59 ½. There are income limits to contributing to this type of 401(k). Work with a Financial Wellness coach to review your options.

401(k) investment options

When you sign up for a 401(k), you may have the ability to choose an investment option for your money. At first, your employer may enroll you in a default option, like a lifecycle or “target-date” fund, which automatically adjusts your mix of investments as you get closer to your target date (for instance, your retirement year). You can stick with this or choose to invest in other types of funds based on your risk tolerance and investment timeline.

401(k) employer match

Some employers may offer to match your 401(k) contributions up to a certain amount each year. The matching contribution will vary from company to company. Call a coach to find out how you can maximize your company’s 401(k).

It’s important to get the details ahead of time if you decide you want to try to get the full match each year. You work hard—make sure your benefits are working for you, too.

Some 401(k) rules to keep in mind

Some 401(k) details, such as eligibility requirements, investment options and vesting timeline, will vary from company to company.

401(k) contribution limits. Like many other types of retirement plans, 401(k)s are subject to annual contribution limits, meaning you can only put away a certain amount of money each year. For 2022, you can contribute up to $20,500.

If you’re age 50 or older and your plan allows it, you can make “catch-up contributions” to help supercharge your retirement savings. Catch-up contributions allow you to put in an extra $6,500, bringing your 2022 maximum contribution to a total of $27,000.

401(k) maximum contribution limits are subject to change each year. Visit IRS.gov for the most up-to-date information.

401(k) required minimum distributions (RMD) rules. Both traditional and Roth 401(k)s are subject to RMD rules. A “required minimum distribution” is the minimum amount of money you must withdraw (or “distribute”) from certain types of retirement accounts each year after you’ve reached a specific age. In other words, you cannot keep your retirement money in a 401(k) forever. According to the IRS, if you have a 401(k), you usually have to start taking RMDs when you turn 72, or 70 ½ if you were born before July 1, 1949.

In some cases, if you’re still working at the company, you may not have to take RMDs from your 401(k) plan until you retire. It’s best to check directly with your 401(k) plan administrator if you have any questions about your RMD obligations.

If you don’t take RMDs on time or in the correct amounts, you could end up paying a penalty of as much as 50% of the amount you were supposed to withdraw.

Review the IRS’s RMD comparison chart for more details on when you need to start taking RMDs. If you have any specific concerns, you may also want to consult with a tax professional.

A 401(k) can be a great tool to help you save for retirement. If your employer offers a 401(k), work with a Goldman Sachs Ayco coach to better understand the retirement and benefit options specific that best fit into your full financial picture.

This article was originally published on Marcus

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