A 401(k) plan is a retirement plan offered by employers to provide retirement benefits for their employees. Employees have the option to defer receipt of some of their wages until retirement. The contributions are pre-tax and made by the employees, with taxes paid when they are withdrawn in retirement. Most employers that offer 401(k) plans will also match your contributions. If your employer does match 401(k) contributions, you should contribute even if you are only able to set aside a small percentage of your salary. Not taking part in a 401(k)-match program is essentially giving away “free” money.
If you choose to participate in your 401(k) program, you can allocate a portion of your salary to your plan every paycheck. The maximum yearly contribution in 2021 is $19,500. If you are over the age of 50 before the end of the tax year, you can contribute another $6,500 for the year.
With a Roth 401(k) plan, your contributions are made with after-tax dollars today with no tax paid when you withdraw from the plan if you are 59 1/2 or older. A Roth 401(k) is a great option if you expect to find yourself in a higher tax bracket when you are retired and unlike a Roth IRA, there are no income limits with a Roth 401(k).
Job Change: What to do with an “Orphaned” 401(k)?
Career changes are a reality that almost everyone will deal with at some point. If you have been contributing to your 401(k), you now have a decision to make with your orphaned 401(k) account. There are four options available to you.
1. Stay with your former employer’s plan
If you have at least $5,000 in your account, you can stay with your former employer’s plan. You normally have 30 to 90 days to decide and if your account is under $5,000 your employer has the option of cashing you out of your plan.
The big advantage of this option is that you don’t have to do anything. If you like the plan, and it’s better than your new employers’ option, this may be the best path for you. The con with this option is that access to your money could be limited, or prohibited completely until retirement. Plus, as a former employee, you may have to pay more for maintenance on the account.
2. Roll your money into your new employer’s plan
Most 401(k) plans accept rollovers from other retirement accounts. Going this route will allow you to have all your retirement money in one place, making it easier to manage. It’s best to compare the options each employer offers before deciding what to do.
3. Transfer your money to an Individual Retirement Account (IRA)
This option gives you the most flexibility with your money which makes it the best option in most cases. More flexibility equals more investment opportunity. With a 401(k) your employer decides which funds you can invest in. Your employer is a restaurant, and they choose the menu, but with an IRA you have control. Also, the fees associated with your 401(k) are rarely disclosed plainly and can often be higher than investments outside the plan.
4. Cash out your 401(k)
While cashing out is an option, it is not a good idea. If you are under the age of 59 ½, not only will you be taxed at your normal rate, but you will also pay a 10% early withdrawal penalty. This is the financial equivalent of the nuclear option. It would both set you back and cause severe damage to your nest egg.
Retirement: Mapping out your 401(k)
If you are getting close to retirement it is a good idea to get with your financial advisor and create a plan for your 401(k). You may need to adjust your contributions to set you up for the retirement you want. As you near your retirement date, figuring out your budget will dictate how much you need to withdraw from your account per year.
No matter what stage you are in there are several options available to you. Boelman Shaw can help you navigate those options and set you up with a plan that helps you meet your goals.
Boelman Shaw provides tax and financial planning services to help our clients get the most from their money. Subscribe to our blog for regular updates on our latest articles.
Tax and accounting services provided through Boelman Shaw & Company, LLC. Advisory services provided through BSC Capital Partners, LLC a state of Iowa registered investment advisor.