18 Frequently Asked 401(k) Questions – Madison.com

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Does your 401(k) seem confusing? Do you have questions about how to invest your contributions, when you can withdraw your money, or how much you should be putting in? You’re not alone. Millions of Americans don’t fully understand how this common type of retirement plan works. With that in mind, here are 18 of the questions I get asked the most about 401(k) plans and what you need to know about each one.

1. What’s the difference between 401(k), 403(b), and 457 plans?

All three are variations of qualified retirement plans offered by U.S. employees, and are quite similar in most ways. The main difference is who offers them. 401(k)s are typically offered by private-sector, for-profit companies and 403(b) plans are offered by nonprofit or public-sector employers. Meanwhile, 457 plans are generally offered by nonprofit and public-sector employers, but are offered in addition to another retirement plan, such as a pension.

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2. Can I use my 401(k) early?

To be clear, you can access the money in your 401(k) whenever you want. However, if you take it before age 59 1/2 without a qualifying exception, you’ll have to pay a 10% IRS penalty. Common exceptions include if you are court-ordered to hand over part of your 401(k) as part of a divorce settlement or to cover certain unreimbursed medical expenses. There’s also the separation from service rule that allows you to withdraw from your 401(k) penalty-free as early as age 55 if you no longer work for the sponsoring employer.

3. What happens to my 401(k) if I leave my job?

It’s up to you. Your main choices may include:

  • Leave the money alone in your old employer’s plan, where it will remain invested.
  • Roll the money into your new employer’s plan.
  • Roll the money into an IRA.
  • Cash it out.

Aside from the last option, which is generally a bad idea, these can all be good options and you can compare them to determine the best choice for you.

4. What if I’m ready to retire before I’m 59 1/2?

There are two main options that allow for 401(k) withdrawals before reaching the standard retirement age. As I mentioned earlier, if you’re at least 55 and no longer work for the employer, you can withdraw from your 401(k) without penalty. Or you can start withdrawing at any age if you agree to take a series of “substantially equal” periodic payments.

5. What if I don’t need to tap into my 401(k) for living expenses?

On the other hand, if you don’t need the money in your 401(k), you can’t just leave it sitting there forever (unless it’s a Roth 401(k)). Starting at age 70 1/2, you’ll have to begin taking required minimum distributions, or RMDs, based on your age and account balance.

6. What is the most I can contribute to my 401(k)?

The 2018 contribution limit for elective deferrals is $18,500. This does not include any matching contributions made by your employer, any mandatory contributions, or any allocations of forfeitures. If you’re 50 or older, you can contribute an additional $6,000 for 2018 as a “catch-up” contribution.

7. What is a Roth 401(k)?

Employers are increasingly offering a Roth option with their 401(k) plans. The biggest difference is the tax treatment. Standard 401(k) contributions are deducted from your taxable income in the year they’re made, but withdrawals will count as taxable income. Roth 401(k) contributions, though, are not tax-deductible, but qualifying withdrawals in retirement will be 100% tax-free.

8. What is a 401(k) loan?

Many 401(k) plans offer participants the ability to borrow money from their accounts. If allowed, these loans can be for as much as $50,000 or half of the account’s value, whichever is less. Participants typically have to pay the loan back, with interest, over a period of up to five years (longer terms for primary residence purchases are available).

9. Is a 401(k) loan ever a good idea?

In most cases, no. While you’ll pay yourself back with interest, your money has more long-term compounding power if it’s simply left alone. However, they do make sense in some cases. For example, if used to consolidate high-interest credit card debt, it can be a good financial move.

10. How do 401(k) investment funds work?

401(k) investment funds are pools of investors’ money that are used to buy stocks, bonds, or cash-equivalent investments. For example, a “growth stock” investment fund would spread its investors’ money across a portfolio of fast-growing companies, such as Amazon, Facebook, and Alphabet (Google), just to name a few.

11. How should I allocate my 401(k)?

As a general rule, I suggest subtracting your age from 110 to determine how much of your 401(k) should be in stocks (equities). The rest should be in bonds (fixed income). So, a 40-year-old should have about 70% stocks and 30% bonds. Check out our asset allocation guide for more details on how to invest your 401(k).

12. What do I have to do to get a tax break for my 401(k)?

Usually nothing. Money that you choose to have withheld from your paychecks and deposited into your 401(k) is generally already subtracted from your federal wages on your W-2 each year. If you’re a business owner or have a solo 401(k), you’ll need to keep track of your deposits and claim them on your tax return.

13. How much tax will I pay when I withdraw from my 401(k)?

If you have a Roth 401(k), you won’t pay a dime in taxes unless you withdraw your investment returns early. With a standard 401(k), your withdrawals are taxed as ordinary income, so the tax rate will depend on which marginal tax bracket you fall into. And if you tap into your 401(k) early without a valid reason as defined by the IRS, you’ll pay an additional 10%.

14. What if I inherit someone else’s 401(k)?

If you inherit your spouse’s 401(k), you can essentially treat it as if it were your own. The standard withdrawal and RMD rules apply.

If you inherit a 401(k) from someone other than your spouse, you generally have the option to get the money in a lump sum (but beware of taxes), over a five-year period or in annual distributions based on your life expectancy.

15. Can I contribute to an IRA and a 401(k)?

It depends on your income. Traditional IRA contributions are allowed for everyone, regardless of income, but the tax deduction has income limitations if you have a retirement plan at work. And Roth IRAs have income limits that apply to everyone, whether or not they have an employer’s retirement plan.

16. Which is better, an IRA or 401(k)?

Both have advantages. 401(k) plans have higher contribution limits and sometimes have lower-cost investment options. On the other hand, IRAs have thousands of additional investment choices and more flexible early-withdrawal options, such as for college expenses or a first-time home purchase.

17. What percentage of my salary should I contribute?

I generally suggest that 401(k) participants aim to save 10% of their salary, not including employer matching contributions. However, at a minimum, you should contribute enough to take full advantage of your employer’s matching program. In other words, if your employer will match your contributions up to 5% of your salary, then 5% of your salary is the bare minimum you should be contributing.

18. How do matching contributions work?

The most common form of matching program involves your employer matching a certain percentage of your contributions, up to a maximum percentage of your salary. For example, a matching limit might look something like “50% of your contributions, capped at 6% of your salary.” This means that if you contribute 6% of your salary to your 401(k), your employer will put in 50% of this amount (3% of your salary), for a total savings rate equal to 9% of your salary.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Facebook. The Motley Fool has a disclosure policy.

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