Pros And Cons: 401 Vs Ira
How To Decide Which Option Is Right For You
Steve Bogner, managing director at New York Citybased wealth management firm Treasury Partners, says choosing how to cash out on your 401 is a decision you should reevaluate each year.
Its very important to do a forensic on your retirement situation at least yearly and just plug in your numbers and use the models to figure out whats really the right solution for you, he says.
In other words, dont set your 401 on autopilot the day you leave the workforce and fail to check in. Each scenario for your distributions can change based on taxes and the state where you live, so be sure to keep a pulse on your unique situation.
How Much Do You Need To Retire Comfortably
Planning for retirement takes work, and unfortunately, many Americans are woefully under-prepared when it comes to the state of their savings. What you need to retire isnt about hitting a specific dollar amount, instead, youll want to be able to replace enough of your income to live comfortably. This suggestion isnt black and white because the standard of living looks different for each individual consider what it takes to live comfortably and maintain your lifestyle. Many experts suggest that youll need roughly 80% of your salary after retirement to avoid making sacrifices.
Create a post-retirement budget based on the lifestyle youd like to maintain. This will serve as a guideline that determines how much you might spend when you retire. In some cases, it may be beneficial to seek financial advice to make sure you are planning accordingly. Most people hope to enter their retirement years debt free, but for some, this wont be the case. You may need to consider these expenses:
- Monthly debt payments
- Replacement vehicles or repair
- Miscellaneous expenses like travel
What role will Social Security play in your income? Generally speaking, Social Security is designed to replace about 40% of the average seniors income. If youll need roughly 80% of your salary to live comfortably, its up to you to make up the remaining 40%. This may be where your 401k comes into play.
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The Federal Thrift Savings Plan
The Thrift Savings Plan is a lot like a 401 plan on steroids, and its available to government workers and members of the uniformed services.
Participants choose from five low-cost investment options, including a bond fund, an S& P 500 index fund, a small-cap fund and an international stock fund plus a fund that invests in specially issued Treasury securities.
On top of that, federal workers can choose from among several lifecycle funds with different target retirement dates that invest in those core funds, making investment decisions relatively easy.
Pros: Federal employees can get a 5 percent employer contribution to the TSP, which includes a 1 percent non-elective contribution, a dollar-for-dollar match for the next 3 percent and a 50 percent match for the next 2 percent contributed.
The formula is a bit complicated, but if you put in 5 percent, they put in 5 percent, says Littell. Another positive is that the investment fees are shockingly low four hundredths of a percentage point. That translates to 40 cents annually per $1,000 invested much lower than youll find elsewhere.
Cons: As with all defined contribution plans, theres always uncertainty about what your account balance might be when you retire.
What it means to you: You still need to decide how much to contribute, how to invest, and whether to make the Roth election. However, it makes a lot of sense to contribute at least 5 percent of your salary to get the maximum employer contribution.
Benefits Of Having A 401k
Different 401k plans come with different perks, each with unique advantages.
Tax advantages: Traditionally, the savings in your 401k account is pre-tax. This means that the amount you contribute is exempt from current federal income tax, which also lowers your taxable income. In this case, you dont have to pay tax on the funds until you actually withdraw them. Since most people are in a lower tax bracket during their retirement years, this may lower the amount they pay in taxes on 401k withdrawals. However, depending on the type of plan you have, the tax break can come when you contribute money or withdraw funds during retirement .
Employer matching contributions: In some cases, employers will offer to match the amount you put into your 401k, which is essentially free money! Employers might offer a certain percentage of what you contribute or even dollar-to-dollar matching. Consider saving up to the maximum annual contribution amount because employer contributions dont count towards your annual limit.
Lifetime contributions: In the case of some retirement accounts and IRAs, there is often an age limit for contributions. However, 401k accounts are not subject to this stipulation so you can contribute funds as long as you are working.
Automatic investment: For many, 401k plans may be the easiest way to save for the future because they automatically deduct funds from your paycheck and place them in the account. This way you dont have to think twice about your savings.
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Is Having A 401 A Good Idea
While you might have good intentions, it can be hard to save. What makes a 401 better than savings is that your contributions come out of your paycheck before you receive it. Its a painless way to save.
A 401 also lowers your tax burden. Since the funds are taken out pretax, the more you put into your 401, the lower your taxable income is, which can add up to significant savings over the years.
As you age, it gets harder to continue to work. You want to be able to relax, travel and spend time with loved ones. Setting aside funds in your 401 helps make your retirement dreams a reality.
To get started with a 401, ask your human resources department how and when you can sign up. Find out whether your employer offers a match. If it does, aim to set aside enough to take full advantage of your employers matching funds.
Even if your employer doesnt match funds, a 401 can help you grow your retirement savings and lower your taxes. So, for most employees, it is a good idea.
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Why Save In A 401
Contributing to a 401 plan can help participants prepare for retirement. By participating in their companys 401 plan, employees can take advantage of matching contributions from their employer, enjoy preferential tax treatment on both pretax and post-tax contributions, harness the power of compounding, and gain access to a wide range of investment options. Check out this article for even more reasons to get started today.
1 Limits are for 2019 and can be subject to change annually. 2 Ordinary income taxes are due on withdrawal. Withdrawals before the age of 59½ may be subject to an early distribution penalty of 10%. 3 This is a hypothetical illustration used for informational purposes only. The marginal tax bracket used is 25%. This lump-sum, after-tax figure doesnt account for the possible change in tax bracket that might occur due to a lump-sum distribution of the taxable amount, nor does it take into effect any applicable tax penalties. There is no guarantee that the results shown will be achieved, and the assumptions provided may not be reflective of your situation. 4 Only applies to qualified distributions, which means the money is withdrawn when you are at least 59½ years old, or on death or disability, and youve held Roth contributions in your account for at least five years .
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Should You Choose A Traditional Or Roth 401
Both plans are excellent, but you might want to choose based on your financial circumstances.
Choose a traditional 401 if you expect to fall into a lower tax bracket in your retirement, which will help you leverage on the immediate tax break. However, if you see yourself in a much higher tax bracket, choose the Roth 401 and avoid paying taxes later.
A Roth plan also makes sense if you are newly employed with many working years ahead of you. Your salary might be low now, but it will increase over time, giving you the opportunity to compound your tax-free earnings with money earned over the years.
How Do You Get A 401
You get a 401 from your employer. Unfortunately, not all employers offer access to a 401 plan. Don’t despair if you fall into that camp. You can still reap the same tax benefits from the other big retirement savings vehicle, an individual retirement account.
All that may raise the inevitable question: What is an IRA? These accounts offer some attractive benefits , albeit with a few downsides . Heres how a 401 differs from an IRA and, if applicable, how to take advantage of both at the same time.
Interested in an IRA? Here’s a comparison of some of our top-rated IRA accounts. We have a full guide to opening an account here.
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What Is A 401k
A 401k is an employer-sponsored retirement account. It allows an employee to dedicate a percentage of their pre-tax salary to a retirement account. These funds are invested in a range of vehicles like stocks, bonds, mutual funds, and cash. Oh, and if you’re curious where the name 401k comes from? It comes directly from the section of the tax code that established this type of plan specifically subsection 401k.
Matching Contributions: How Much And When
The specific terms of 401 plans vary widely. Other than the necessity to adhere to certain required contribution limits and withdrawal regulations dictated by the Employee Retirement Income Security Act , the sponsoring employer determines the specific terms of each 401 plan.
Your employer may elect to use a very generous matching formula or choose not to match employee contributions at all. Some 401 plans offer far more generous matches than others. Whatever the match is, it amounts to free money added to your retirement savings, so it is best not to leave it on the table.
Refer to the terms of your plan to verify if and when your employer makes matching contributions. Not all employer contributions to employee 401 plans are the result of matching. Employers may elect to make regular deferrals to employee plans regardless of employee contributions, though this is not particularly common.
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Move Your Money Into An Individual Retirement Account
This choice gives you maximum control and flexibility. With a 401 plan, the employer chooses the investments and makes the rulesand the rules vary from plan to plan. With an IRA, youre in charge.
- Unlimited investment choices instead of a small menu. Every 401 plan has limited investment options by contrast, you have total freedom of choice in an IRA, which can be invested in as many mutual funds, stocks and bonds as you want.
- Greater control over your investment expenses. 401 plan fees are rarely disclosed, and in many cases they’re higher than what you’d pay for comparable investments outside the plan. Picking low-cost funds for your IRA can save you tens of thousands of dollars over time.
- Greater freedom to name beneficiaries. The beneficiary of your 401 plan, by law, must be your spouse you have to obtain a signed release from him or her if you want to name anyone else. With an IRA, you can name any beneficiary you wish.
- Taxes will be withheld unless you move the money from your 401 to an IRA via a trustee-to-trustee transfer. To avoid this issue, first set up a new IRA then ask your old employer to transfer your money directly from the 401 plan into the new account.
Can I Contribute 100 Percent Of My Salary To A 401
If your earnings are below $19,500, then the most you can contribute is the amount you earn. It should also be noted that a 401 plan document governs each particular plan and may limit the amount that you can contribute. This applies especially to highly compensated employees, which in 2021 is defined as those earning $130,000 or more or who own more than 5 percent of the business.
Sponsors of large company plans have to abide by certain discrimination testing rules to make sure highly compensated employees dont get a lopsided benefit compared to the rank and file. Generally, highly compensated employees cannot contribute higher than 2 percentage points of their pay more than employees who earn less, on average, even though they likely can afford to stash away more. The goal is to encourage everyone to participate in the plan rather than favor one group over another.
There is a way around this for companies that want to avoid discrimination testing rules. They can give everyone 3 percent of pay regardless of how much their employees contribute, or they can give everyone a 4 percent matching contribution.
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What Happens If You Dont Name A 401 Beneficiary
Selecting a 401 beneficiary might seem like a formality, but its incredibly important if you want to have a say in who inherits your account. If youre married, your spouse is typically going to be the automatic beneficiary of your 401, even if you dont officially name them on the beneficiary form there may, however, be some exceptions depending on your plan. But if youre single, or want someone other than your spouse to inherit your account, naming a beneficiary can prevent a lot of trouble for your heirs. Even if your spouse will be your automatic beneficiary, it may be a good idea to fill out the form for your records.
Typically, retirement accounts avoid the probate process and transfer directly to the named beneficiaries. Probate is a legal process in which the court determines whether a deceased person left a will and ensures the deceased persons assets are distributed according to their will .
If you dont have any living 401 beneficiaries when you die, your 401 can wind up in probate, and several problems can arise:
What Is The Difference Between A Traditional And Roth 401 Plan
There are two common kinds of 401 plans: traditional and Roth. These plans have some similarities: They are subject to the same annual contribution limit and may offer the same investment options. However, traditional and Roth 401 plans differ in terms of the tax benefits they offer.
Subject to income tax
Tax-free after age 59 ½*
*Only if the distribution satisfies certain conditions, for example that it has been at least five years since the first Roth contribution, or that the participant is disabled.
IRS.gov. Data as of Dec. 2020.
A traditional 401 plan is sometimes referred to as a pre-tax 401 plan. You contribute to the plan with before-tax dollars. Because you dont pay taxes on the money you put into the plan, you must pay taxes when you withdraw it. This structure could be an advantage if youre in a high tax bracket today but expect to be in a lower one when retired.
With a Roth 401 plan, the opposite is true. You save after-tax dollars in the account. Because youve already paid taxes on what youre saving, your withdrawals are considered qualified distributions and wont be taxed as long as you meet both of the following criteria:
- Youve had the account for at least five years.
- You begin to make withdrawals either after youve turned 59½ or due to disability.
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How Does The 401 Plan Work
Contributions: Teammates have the potential to receive 7 – 8% in Atrium Health contributions.
- After three months of service, you automatically will be enrolled in the Atrium Health 401 Retirement Savings Plan at a pretax contribution rate of 3% of eligible compensation.
- These contributions will be matched by Atrium Health based on how much you contribute.
- Atrium Health matches your contribution on each paycheck in which you make a contribution up to limits determined by the IRS. Catch-up contributions are not matched.
|(based on years of service and regardless of whether you save through the plan||0%|
- Each year Atrium Health will contribute 2% of your pay to your account, regardless of whether you save through the plan
- Contribution made annually
- We strive to make the annual contribution during the first quarter of each year. You’ll be notified once the contribution has been made and will then be able to log into Empower’ Retirements website to see your exact amounts.
- Total maximum match is 4%. In order to receive the full 4% match, you must save 6% of your pay through the plan
- Atrium Health matches your contribution on each paycheck in which you make a contribution up to limits determined by the IRS. Catch-up contributions are not matched
|If you have|
|20 or more yrs||2% of pay contribution|