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Ah, the 401(k)—the modern corporate pension. Having a 401(k) is a smart way to make sure that you have enough money later on down the road, and if you're like many other Americans, it's also an epic retirement plan option given to you by the company you're employed by.
The thing about having a 401(k), though, is that you may not really know where to start investing—or why it's so good for you to do so. Here's what you need to know about the most frequently asked 401(k) questions, and how their answers could affect you in 20 years.
Why were 401(k)s invented?
Yes, this is one of the most frequently asked 401(k) questions out there—especially by people who much rather would have seen a pension after working so hard. (We all wish we could have our own perfect pension plan, but let's face it, it's not happening.)
In the olden days, people used to get pensions after a certain set amount of years they worked. The problem with pensions is that they are pricey, and in many situations, also untenable.
401(k)s were a better answer that allowed businesses to give more control to employees, all while cutting costs. So, that's why they are around.
What is a 401(k)?
A 401(k) plan is a retirement savings account that's sponsored by an employer. This kind of plan lets workers invest their money in their future before taxes are taken out, which means that there's both tax incentives and retirement incentives to have one.
In many cases, employers will match the amount of money that you put into your 401(k). This is called "employer matching," and it's basically like an amazing tax deduction in its own unique way. You basically get to see more money later on in life, much like a good deduction.
To find out if you have a 401(k) option in your company's benefits plans, talking to HR can help. (They also usually have guide sheets on the company's most frequently asked 401(k) questions that can clear things up about policy and protocol, if you're curious.)
With a 401(k), you get to choose how your money is invested—and that means that you get to enjoy the benefits of having more control over your future.
How much should I put into a 401(k)?
As much as possible, realistically. If you want to be able to afford a nice lifestyle in one of the best places to retire, you will need a pretty chunk of change.
Realistically, the US government won't allow you to contribute more than $18,000 in your 401(k). Another legal cap says that the maximum of any contribution (including employer matching) cannot be more than 100 percent fo your salary for that year.
But still, getting close to maxing out is a great way to make your retirement great. If you're older than 50, you can actually add more to your 401(k)—it's called a "catch up."
When can I withdraw money from my 401(k) account?
Here's where many of the most frequently asked 401(k) questions lie—in the money aspect of things. Hopefully, we can offer some refreshers.
401(k) withdrawals are known as 401(k) distributions in finance lingo, and truthfully, there are really only a couple of times where your 401(k) will become accessible to you. The only two times are as follows:
- When your employment becomes terminated via death, disability, firing, or quitting.
- When your 401(k) account is terminated by your employer.
However, there are certain times where 401(k) distributions may be accessible regardless of what your employer does. These situations include the following:
- Employee rollover, and any voluntary contributions you make can be withdrawn as you see fit.
- Profit sharing contributions are also accessible at any time.
- Most 401(k) deferrals can't actually be withdrawn until age 59.5, so you still probably have a while to go.
- 401(k) deferrals, nonsafe harbors, voluntary contributions, and rollovers can be withdrawn during a "hardship" time.
That being said, you can dip in early—but it comes at a price. You will have to pay a ten percent penalty tax if you choose to cash out your 401(k) early.
How do the tax rates work on 401(k) distributions?
This is one of the most frequently asked 401(k) questions estate planners will get—and sadly, it's also one of the most disappointing ones when you hear the answer. You see, unlike Roth IRAs, 401(k)-related income is taxed.
If you made a rollover-eligible distribution, the amount you can get will be automatically reduced by 20 percent, due to Federal Withholding tax. Distributions that have no rollover eligibility will end up subject to a ten percent tax rate.
Certain situations do allow you to avoid the ten percent federal income tax penalty, though. These include:
- Being the beneficiary of a Qualified Domestic Relations Order
- Being disabled
- Being dead
- The withdrawal being due to a testing failure in the 401(k) plan
- You terminated your work after turning 55
- You turned 59.5 years of age.
Depending on which state you live in, you may also deal with state taxes, too. If you are not sure whether or not you'd be taxed, chances are that HR or your local tax attorney will have a sheet of the most frequently asked 401(k) questions you can check out.
What happens if my company isn't on stable financial ground?
Good news here on two fronts. First off, this is one of the most frequently asked 401(k) questions as searched online. You're not alone when it comes to worrying about this retirement issue.
Second, you have no need to worry. Companies that go under cannot touch the 401(k)s of former or current employees. So, even if your company tanks, you will still be in the clear.
If your company dies out, you should roll your 401(k) into a Roth IRA. This will help you avoid taxes and will also let your nest egg grow a bit.
Can I make a home loan using my 401(k)?
This is one of the most frequently asked 401(k) questions that people usually assume they know the answer to. Most people assume that you can't, but is that the real truth? Surprisingly, it's not.
A 401(k) can let you buy a home. If you want to use your 401(k) to put a down payment on a house, it is possible. There are two primary routes for doing this: the loan route and using a hardship withdrawal route.
With the loan route, you don't have to worry about taxes or penalties. With the hardship route, you might. However, eligibility is often what causes someone to choose their route—so it's important to talk to a professional about it.
How many 401(k)s can I have, anyway?
If you're a person who lives a life of hopping from job to job, you already know why this is one of the most frequently asked 401(k) questions out there. It's kind of a hassle to have to constantly roll over a million 401(k) into your newest plan, right?
Well, there's good news in this, too: you have no limit to the number of 401(k)s you can have. The only catch is that you can only contribute to the one at your current employer.
Consolidating your 401's into the newest one is a good idea, but by no means is it necessary. When they're consolidated, it's easier to see your account balance, take care of
How do I find an old 401(k) account from an old employer?
Oof, this can be tricky, but thankfully, it is doable. Surprisingly, it's also one of the more frequently asked 401(k) questions out there. If you put your money into a 401(k), it's protected by federal law. So, it didn't just evaporate. Here are the best options you can consider:
- Call your old employer. This is the quickest way to find and access your old account. By law, they are required to give you access, since it's your money.
- Find old records of your 401(k) to get contact information dealing with the firm that has it. Sometimes, this is the best way to get to your 401(k) after your company goes under. 401(k) are managed by third parties, so it's not like it would disappear when the company you worked at died.
- Search for the corresponding Form 5500 online. You can do this by going to freeERISA.com.
- Check with the National Registry, or see if there's an entry in the Abandoned Plan Database. Both allow you to find old 401(k)s, as well as old Roth IRAs that have been deemed abandoned.
If I divorce, what happens to my 401(k) plan?
When it comes to divorce courts, it's not surprising that this is one of the most frequently asked 401(k) questions in the books. Truthfully, it's not a clean-and-cut deal. Much of what you can do with your 401(k) retirement plan, including dividing it up, is decided by the people who run it.
In many cases, the 401(k) plan will be split 50/50 with your soon-to-be-ex spouse. This happens via a QRDO order. However, your attorney can also get you to keep the 401(k) and just give up similar assets if you feel that's a better option.
That being said, if you're looking at divorce, talking to a lawyer in your state may be a better idea.