Other Benefits Of A 401
Even for employers who do not offer any matching program, every employer with a 401 plan is responsible for administering the plan. That may seem like its no big deal, but it actually saves quite a bit of trouble for the employees. As an employee in a 401 plan, you dont have to worry about the complicated rules and regulations that need to be followed, or about making arrangements with the funds in which you invest your moneyyour employer takes care of all of that for you. Thats quite a bit of saved paperwork.
At the same time, employees who participate in a 401 maintain control over their money. While employers provide a list of possible investment choices, most commonly different sorts of mutual funds, employees have quite a bit of freedom to decide their own strategy. Whether you are willing to take on a little more risk with your investments, or if you would rather play it safe, theres probably an option for you.
Continued Growth Vs Inflation
Remember that your retirement savings accounts don’t grind to a halt when you begin retirement. That money still has a chance to grow, even as you withdraw it from your 401 or other accounts after retirement to help pay for your living expenses. But the rate at which it will grow naturally declines as you make withdrawals because you’ll have less invested. Balancing the withdrawal rate with the growth rate is part of the science of investing for income.
You also need to take inflation into account. This increase in the cost of things we purchase typically comes out to about 2% to 3% a year, and it can significantly affect your retirement money’s purchasing power.
Penalties For Cashing Out Your 401 Early
Of course, the biggest consequence comes from the penalties youll pay. You already know youll likely have to pay taxes on your cash out. But if you take out the money before you reach 59.5 years of age, the IRS will charge a 10 percent early withdrawal penalty. The money will also be included with your gross income for the year and taxed at the rate that applies to your tax bracket. You could find that withdrawing the funds moves you into a higher tax bracket.
One way around this is to qualify for a 401 hardship withdrawal, which can exempt you from early withdrawal penalties. The following events can qualify you for a hardship exemption, depending on the rules laid out by your plan:
- Medical expenses
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What If You Only Need The Money Short Term
Although there are other qualifying exceptions to withdraw IRA or 401k assets penalty-free, those listed above are the major ones. But suppose youre not interested in paying any taxes at all. You can still use your 401k to borrow money via a loan. The interest goes to you, the loan isnt taxable, and it wouldnt show up on your credit report. Heres how it works.
How Long Can A Company Hold Your 401 After You Leave
When you change jobs, it might be unclear how long a company can hold your 401 after you leave. Learn more about your 401 waiting period.
When you leave your job, your employer can choose to hold or disburse your 401 money depending on your age and the amount of retirement savings you have accumulated. How long a company can hold your 401 depends on how much asset you have in the account: the company can hold for as long as you want unless you decide to rollover to a new plan or take a cash out. However, you must have at least $5000 in your 401 if you want the company to continue managing your plan. For amounts below $5000, the employer can hold the funds for up to 60 days, after which the funds will be automatically rolled over to a new retirement account or cashed out.
If you have accumulated a large amount of savings above $5000, your employer can hold the 401 for as long as you want. However, this may be different for small amounts, which the employer can cash out and send in a lump sum, or rollover your 401 into an Individual Retirement Account .
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Annual 401 Contribution Limits
For 2020 and 2021, the maximum an employee can contribute to a 401 is $19,500. If youre 50 or older, you can deposit an extra $6,500 in catch-up contributions, for a combined contribution of $26,000. These limits apply to all 401 contributions, even if you split them between pre-tax and Roth contributions, or you have two employers in a year and thus two separate 401 accounts.
About a fifth of employers also allow after-tax, non-Roth contributions. In such cases, a combined employee and employer contribution limit applies. In other words, your employers contributions, combined with your pre-tax, Roth and after-tax contributions, cant exceed this limit. For 2020, that combined limit is $57,000, or $63,500 for those 50 or older. For 2021, the total limit rises to $58,000 or $64,500 for those 50 or older. Unlike Roth contributions, these extra after-tax savings grow tax deferred, but not tax free.
The contribution limits are updated as frequently as annually based on inflation, so its important to check back to see if you can increase your contribution if youve been contributing the maximum.
Rollover Over To An Ira
If you want to diversify your investments, you can transfer your savings to an IRA to enjoy more investment options. You can also find better-performing investments that pay higher returns than the investment options available in a 401.
If you have other old 401 plans with former employers, you can do a direct rollover to your IRA to make it easier to manage your retirement savings in a single account. A direct rollover helps you avoid paying taxes and penalties on the distribution.
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What’s So Great About 401 Accounts
A 401 is a popular type of employer-sponsored retirement plan that’s available to all employees 21 or older who have completed at least one year of service with the employer, usually defined as 1,000 work hours in a plan year. Some employers enable new employees to join right away, even if they haven’t met this criterion yet.
In 2021 you’re allowed to contribute up to $19,500 to a 401 or up to $26,000 if you’re 50 or older. These limits are much higher than what you find with IRAs, and they enable you to set aside a fairly large sum annually.
Most 401s are tax deferred, so your contributions reduce your taxable income each year. You must pay taxes on your distributions in retirement, but you may be in a lower tax bracket by then, in which case you would save money. Some employers also offer Roth 401s. You pay taxes on contributions to these accounts now, but you’ll get tax-free withdrawals in retirement.
Some employers also match a portion of their employees’ 401 contributions, which can make the task of saving for retirement a little easier. Each company has its own rules about matching, so consult with your HR department to learn how yours works.
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What Options Do I Have For My Current 401
When you leave an employer, you have several options:
- Leave the account where it is
- Roll it over to your new employers 401 on a pre-tax or after-tax basis
- Roll it into a traditional or Roth IRA outside of your new employers plan
- Take a lump sum distribution
The truly smart move for you depends on your own individual circumstances and goals.
Some items to consider include:
- Your current account balance
- Whether you fear collection actions, because workplace plans provide creditor protection that IRAs dont
- Quality of your new companys retirement plan versus your former plan in terms of investment options, fees and whether or not loans are permitted
- Options available to you in an IRA outside of your employers plan
The good news is that you do not have to make any decisions about your existing 401 immediately. You may want to speak with a financial advisor first to discuss your options.
Making A Hardship Withdrawal
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Early Money: Take Advantage Of The Age 55 Rule
If you retireor lose your jobwhen you are age 55 but not yet 59½, you can avoid the 10% early withdrawal penalty for taking money out of your 401. However, this only applies to the 401 from the employer you just left. Money that is still in an earlier employer’s plan is not eligible for this exceptionnor is money in an individual retirement account .
If your account is between $1,000 and $5,000, your company is required to roll the funds into an IRA if it forces you out of the plan.
A Tax Savings Example
Assume you make $50,000 per year. You decide to put 5% of your pay, or $2,500 a year, into your 401 plan. You’ll have $104.17 taken out of each paycheck before taxes have been applied if you get paid twice a month. This money goes into your plan.
The earned income you report on your tax return at the end of the year will be $47,500 instead of $50,000, because you get to reduce your earned income by the amount you put in. The $2,500 you put into the plan means $625 less in federal taxes paid if you’re in the 25% tax bracket. Saving $2,500 for retirement therefore only costs you $1,875.
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The Hardship Withdrawal Option
A hardship withdrawal can be taken without a penalty. For example, taking out money to help with economic hardship, pay college tuition, or fund a down payment for a first home are all withdrawals that are not subject to penalties, though you still will have to pay income tax at your regular tax rate. You may also withdraw up to $5,000 without penalty to deal with a birth or adoption under the terms of the SECURE Act of 2019.
A hardship withdrawal from a participants elective deferral account can only be made if the distribution meets two conditions.
- It’s due to an immediate and heavy financial need.
- It’s limited to the amount necessary to satisfy that financial need.
In some cases, if you left your employer in or after the year in which you turned 55, you may not be subject to the 10% early withdrawal penalty.
Once you have determined your eligibility and the type of withdrawal, you will need to fill out the necessary paperwork and provide the requested documents. The paperwork and documents will vary depending on your employer and the reason for the withdrawal, but once all the paperwork has been submitted, you will receive a check for the requested fundsone hopes without having to pay the 10% penalty.
You Can Take It With You
If you leave your job someday for another, you can take your 401 with you. This won’t go into a box with your other belongings rather, you’ll need to roll over that account into a new one and for many people, converting that 401 to an IRA is a great idea. You’ll want to consult our guide for 401 rollovers when that time comes.
About the author:Dayana Yochim is a former NerdWallet authority on retirement and investing. Her work has been featured by Forbes, Real Simple, USA Today, Woman’s Day and The Associated Press.Read more
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K Withdrawal Rules: How To Avoid Penalties
401k plans, IRAs and other tax-advantaged retirement savings accounts are common ways to save for retirement, and millions of Americans pour money into them every year. Its generally wise to avoid withdrawing money from your 401k, as there are often hefty penalties and taxes to consider for early withdrawals.
Sometimes, however, unplanned circumstances force people to withdraw funds from their 401k early. So if you find yourself in a place where you need to tap your retirement funds early, here are some rules to be aware of and some options to consider.
How Long Can A Company Hold Your 401 Funds When You Withdraw
When you leave a job, you can decide to cash out your 401 money. Generally, when you request a payout, it can take a few days to two weeks to get your funds from your 401 plan. However, depending on the employer and the amount of funds in your account, the waiting period can be longer than two weeks.
Each company has different time frames for making distributions when you request a payout. Check the waiting period of your employerâs 401 plan by checking the summary plan description given by the company. The waiting period starts when you request a payout up to when you receive the cash distribution, or funds are rolled over to an IRA or 401.
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Option : Roll Over Your Old 401 Into An Individual Retirement Account
Still another option is to roll over your old 401 into an IRA. The primary benefit of an IRA rollover is having access to a wider range of investment options, since youll be in control of your retirement savings rather than a participant in an employers plan. Depending on what you invest in, a rollover can also save you money from management and administrative fees, costs that can eat into investment returns over time. If you decide to rollover an old 401 into an IRA, you will have several options, each of which has different tax implications.
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How To Calculate Your Required Minimum Distributions
Use IRS Publication 590-B to calculate your 401k RMDs it includes life expectancy tables that correspond to your specific age. Take the value of your 401k as of Dec. 31 of the previous year and divide that number by the number of your IRS life expectancy remaining years. The resulting number is your RMD, which is the minimum amount you must withdraw from your 401k that year.
Use this guide to determine which table to work from in Publication 590-B and keep in mind that 403b plans might be subject to different rules:
- Single life expectancy table: Use this table if you are the beneficiary of an inherited retirement account.
- Joint and last survivor table: Use this if your spouse is more than 10 years younger than you and is the sole beneficiary of your account.
- Uniform lifetime table: Consult this table if your spouse is not more than 10 years younger than you or is not the sole beneficiary of your account.
Different rules and requirements apply if you have 457 plan because its not considered a qualified plan. You can take regular distributions from a 457 plan as soon as you retire, regardless of whether youve turned 59.5. The 10 percent early withdrawal penalty does not apply to these plans, but all distributions are still taxed as ordinary income.