These Accounts Can Be A Great Way To Save For Retirement While Giving You A Tax Break Now But Beware Of The Fees Plan Providers Charge For 401s
When you start a new job, one of the first decisions youll likely make is whether to participate in the companys 401 plan. The earlier you start saving in a 401, the better. But no matter how old you are, its never too late to contribute more to your account and bolster your future retirement security.
Here are 10 things you need to know about these retirement plans.
You Can Get Around The 401 Restrictions
Not to get too complicated, but there are also exceptions to some of the above restrictions that let you withdraw your 401 money penalty-free. For example, if youre buying a house or a couple of other things, you can withdraw money penalty-free. But for all intents and purposes, this is money youre putting away for 30 years.
What Is A 401
The more interesting angle is what a 401 can do for you. The 401 is a powerful resource for achieving financial independence, especially when you start using it early in your career. Said another way, if you like money and wish to have more of it in the future, you can use a 401 to make that happen.
Read on for a closer look at how the 401 works, when you can withdraw funds from a 401, and what happens to your 401 if you change jobs.
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Tips For A Financially Successful Retirement
- No matter how close or far you are from retirement, juggling all of your accounts and investments on your own can get difficult. A financial advisor can take a comprehensive look at your finances and help manage your money on your behalf. SmartAssets free matching tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals, get started now.
- During the retirement planning process, its important to think about the retirement tax laws of the state you want to retire in. By minimizing your retirement tax burden, you can maximize the value of your savings in retirement.
The Costs Of Early 401k Withdrawals
Early withdrawals from an IRA or 401k account can be expensive.
Generally, if you take a distribution from an IRA or 401k before age 59 ½, you will likely owe:
- federal income tax
- 10% penalty on the amount that you withdraw
- relevant state income tax
Calculate It:401k Withdrawals Before Retirement
The 401k can be a boon to your retirement plan. It gives you flexibility to change jobs without losing your savings. But that all starts to fall apart if you use it like a bank account in the years preceding retirement. Your best bet is usually to consciously avoid tapping any retirement money until youve at least reached the age of 59 ½.
If youre not sure you should take a withdrawal, use this calculator to determine how much other people your age have saved.
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Pros And Cons: 401 Vs Ira
Have A Realistic Understanding Of When You Want To Retire
Having clearly defined goals will help you determine how much you should have saved based on your personal goals. Your savings objectives will be different if you plan to retire at 50 than if you plan to continue working past 70. Additionally, its important to determine as accurately as you can what your cost of living will be in retirement. How much do you need to spend per year to maintain the lifestyle that you want for the rest of your life? Have a good sense of what your costs will be so you can factor that into your overall retirement strategy. Really evaluate how long you want to continue working, and what retirement age is realistic for you based on your income and your current level of savings.
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Ways To Withdraw Your 401
There are several ways to go about withdrawing your money in retirement.
- Rollover your funds: Instead of keeping your money in a 401, you can roll it over into a new account to keep it growing in retirement with more investment options.
- Take regular distributions: You can contact the financial institution managing your 401 and set up periodic payments to give you a fixed stream of income, much like a paycheck. You can also opt to take the distribution as you need them, as long as you take out the minimum required amount.
- Purchase an annuity: You can also purchase an annuity to ensure a fixed stream of payments.
- Take a lump sum: This is often not recommended by financial experts, but you have the ability to take out the money all at once.
Which option you pick will depend on your financial situation and goals in retirement. A financial planner can help you develop a plan that fits your needs.
How Is An Ira Different From 401k
401k accounts are associated with your employment, as contributions are taken out of your wages before taxes. A traditional IRA is similar to a 401k in that contributions aren’t taxed , but the key difference is that they are independent of your employer.
A Roth IRA is also independent, but contributions are made after taxes. Withdrawals from your Roth IRA are tax-free, which makes them a smart choice if you think taxes will be higher in the future.
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What Are The Pros And Cons Of Withdrawal Vs A 401k Loan
|Pros and Cons of 401k Withdrawal vs. 401k Loan|
A Beginner’s Guide To Understanding 401k Plans
The number 401k is synonymous with a retirement savings plan, but how many of us actually know all the rules around 401k accounts? Or where that number comes from?
To answer the most basic question right off the bat, the number 401 come from the internal revenue code that allows employers to help employees develop a retirement saving option to be taken directly out of their earnings before income taxes are deducted.
If you are seeking investment advice, you should definitely contact a financial advisor, or ask your local community bank or credit union for personal financial advice. If you want to understand what a 401k is and how setting one up works, this is the place.
We’ll walk you through all the finer details, but we also know you’re busy, so we’ve whipped up this handy table of contents for you. Feel free to self-serve some of the most frequently asked questions about 401k plans, or binge it all, top to bottom.
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Periodic Distributions From 401
Instead of cashing out the entire 401, you may choose to receive regular distributions of income from your 401. Usually, you can choose to receive monthly or quarterly distributions, especially if inflation increases your living expenses. If the 401 is your main source of income, you should budget properly so that the distributions are enough to meet your expenses.
For example, if you have accumulated $1 million in retirement savings, you can choose to receive $3,330 every month, which amounts to approximately $40,000 annually. You can adjust the amount once a year or every few months if your 401 plan allows it. This option allows the remaining savings to continue growing over time as you take periodic distributions.
Heres How Much The Average Saver Has For Retirement
A recent survey by financial services firm BlackRock broke down the average retirement balance by age and by whether or not participants had access to a workplace retirement account. Here are the results:
Average Balance With a Workplace Retirement Account
Average Balance Without a Workplace Retirement Account
21 to 30
Data source: The 2022 BlackRock Read on Retirement survey.
One big caveat here is that all participants surveyed reported at least $5,000 in retirement savings. Those who dont have any money saved for retirement were left out, which skews the results upward.
If youre nowhere near the averages for your age right now, that doesnt mean you should panic. And if youre ahead of these numbers, that doesnt mean you can relax and take it easy. Everyone has personal retirement goals and a timeline. You need to know how much you have to save for your retirement goals and then come up with a plan that will help you get there.
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What Are My Contribution Limits
A word of caution: Plans vary. Minor exceptions are all over the place. Retirement plans can get as complex as the needs of the people trying to save their money. Also, companies sometimes match your contributions with their own cash, but they contribute shares in the company itself. That can be risky if your plan isn’t diversified enough, and the company’s stock tanks.
But generally you can dial up or down how much of your paycheck you put into your 401 account the thing that contains the money you’ve invested. You can’t access any of this money before age 59-1/2 unless you’re willing to stomach a penalty.
As of 2019, if you’re under age 50 have a 401 plan set up through your job, you can put up to $19,000 of what you get paid into your account. At age 50 and above, you can contribute up to $25,000.
What Happens To My 401k If I Change Jobs
You have a couple of options, but the one most people would recommend is a 401k rollover. A 401k rollover is when you transfer your funds from your old 401k from your previous employer to an individual retirement account or to a new 401k plan set up with your new employer.
When you roll over the funds all of the funds to a qualifying IRA or 401k account, you do not have to pay taxes on the transfer. You will receive a 1099 stating that the funds changed accounts. Again, this is not taxable income. The tax form is for information purposes and includes a code that identifies it to the IRS as non-taxable.
A much less popular option is to cash out your 401k. This comes with massive penalties, income tax, and an additional 10% withholding fee. Keep reading for details on those penalties.
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What To Do About Your Retirement Accounts Today
I want you to spend the weekend getting educated about 401s and Roth IRAs. On Monday, I want you to open up your retirement accounts and start funding them. Call your HR department and get your 401 squared away. Call a few discount-brokerage firms to get a Roth account, too. Dont worry about where to invest your money just yet. Take it one step at a time and just open your accounts.
Oh yeah, and one more thing: I already anticipate 1 billion comments debating fiscal policy, the effectiveness of Roth IRAs vs. 401 vs. Keogh plans vs. SEP IRAs vs. Simple IRAs, and other crap. Please dont waste your time on this minutiae. The problem is not debating the tiny details. The problem is that most people dont have retirement accounts. The problem is that most people dont fund it as regularly as they should, even though $100/month makes a big difference. And the problem is that most people dont open retirement accounts early enough.
So let the fools debate. For you, just get your accounts open.
How Does The Tsp Part Of Federal Retirement Work
As I stated earlier, the government designed FERS employees to have three pools of money in retirement: FERS annuity, social security, and the TSP.
What is the TSP? The TSP is a defined contribution plan similar to a 401. You can contribute up to $19,500 per year to your TSP. The government matches the first 5% of your TSP contributions and this match does not count towards your $19,500 limit.
You can contribute to a traditional, tax-deferred TSP, or a Roth TSP. Both flavors of the TSP help you avoid paying taxes. If you need to you will want to think about your current tax bracket and your tax bracket in retirement.
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Opening Your Roth Ira
Its easy. You can go through your current discount brokerage, like ETrade or Datek. You can also go through an independent service like Vanguard. Call them up, tell them you want to open a Roth IRA, and theyll walk you through it.
Special note: These places have minimum amounts for opening a Roth IRA, usually $3,000. Sometimes theyll waive the minimums if you set up an automatic payment plan depositing, say, $100/month. Other times, youre out of luck. Shop around.
Once your account is set up, your money will just be sitting there. You need to do things then: First, set up an automatic payment plan so youre automatically depositing money into your Roth. How much? Try doing as much as youre comfortable with, plus 10%. Second, decide where to invest your Roth money it can be in stocks, index funds, mutual funds, whatever. Read my introductory articles for more on how to choose. I also created a video about how to choose a Roth IRA.
Heres a quick illustration of the power of continually adding money to your investment account:
When You Don’t Roll Over
Cashing out your account is a simple but costly option. You can ask your plan administrator for a checkbut your employer will withhold 20 percent of your account balance to prepay the tax youll owe. Plus, the IRS will consider your payout an early distribution, meaning you could owe the 10 percent early withdrawal penalty on top of combined federal, state and local taxes. That could total more than 50 percent of your account value.
Think TwiceThe repercussions of taking money out now could be enormous: If you took $10,000 out of your 401 instead of rolling it over into an account earning 8 percent tax-deferred earnings, your retirement fund could end up more than $100,000 short after 30 years.
If your former employers plan has provided strong returns with reasonable fees, you might consider leaving your account behind. You dont give up the right to move your account to your new 401 or an IRA at any time. While your money remains in your former employers 401 plan, you wont be able to make additional contributions to the account, and you may not be able to take a loan from the plan. In addition, some employers might charge higher fees if youre not an active employee.
Further, you might not qualify to stay in your old 401 account: Your employer has the option of cashing out your account if the balance is less than $1,000 though it must provide for the automatic rolling over of your assets out of the plan and into an IRA if your plan balance is more than$1,000.
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Ira Vs : Which Is Better And Whats The Difference
There are two main types of tax-advantaged retirement accounts: a 401, which is attached to a job, and an IRA, which usually is separate from a job.
IRA stands for Individual Retirement Account. With the exceptions of and SIMPLE IRA plans, you wont be getting a company match within your IRA. Its on your shoulders.
The contribution limits also are much lower: $6,000 in 2021 if youre younger than 50 with an additional $1,000 in catch-up contributions allowed if youre 50 or older.
Plus, with a Roth IRA , you may be disqualified from contributing at all if you make too much money.
You can contribute to a 401 and an IRA simultaneously. However, if your company offers a low-cost 401 plan , Clark recommends that you contribute to your 401 until you reach the IRS limit then think about contributing to an IRA.
With a 401, the money automatically comes out of your paycheck, Clark says. You dont have to have the best of intentions to put the money in. Automatic is great.
Want to explore IRA vs. 401 in greater detail? Ive got you covered with this article. You can also learn more about Clarks recommended priority list for 401, IRA, HSA and taxable investment accounts here.