Pop quiz: How a 401 (k) actually works? You probably know that the money is coming out of your paycheck and going into the account, that the government is giving you tax relief on your contributions, and that the money grows over time to help cover expenses in retirement.
A lot of people think that’s all there is to know, but there are a few other things everyone should understand about their 401 (k) if they are to get the most out of it. Here are three.
1. Contribution ceilings
You are allowed to contribute up to $ 19,500 to a 401 (k) in 2020 or $ 26,000 if you are 50 or older. This does not include funds matched by the company. If you accidentally contribute more than that, you must ask your plan administrator to withdraw the excess contribution, along with the income associated with it, before the tax deadline for the year. You will owe taxes on your excess carryforwards and the interest you have incurred, but you will not owe the 10% early withdrawal penalty.
If you don’t correct your mistake by the tax deadline – usually April 15 of the following year – the over-contribution is essentially taxed twice. You pay taxes the year you paid the funds and again when you withdraw the funds later.
If you’ve maximized your 401 (k) for the year and want to put more money aside for retirement, you can put an additional $ 6,000 in an IRA in 2020 or $ 7,000 if you’re 50 or more.
Contribution limits change from year to year, so keep an eye out for them, especially if you run into them on a regular basis. Once you turn 50, you can start saving even more money for your retirement.
2. The costs
Yes, your 401 (k) charges you a fee. You might not realize it because the money goes straight out of your account, so you never get an invoice. How much you pay depends on your business plan, the number of employees involved, and what your money is invested in. Large companies are generally able to offer more affordable 401 (k) than small companies because they have more employees to absorb. administrative costs, such as record keeping costs.
Your investments have their own costs, which can affect how quickly your retirement savings grow over time. All mutual fund has an expense ratio, an annual fee that all shareholders must pay. You can find it as a percentage of your assets in your prospectus. Talk to your 401 (k) plan administrator if you’re unsure of how to find out what you’re paying. You should aim to pay 1% or less of your assets in fees each year.
If you are paying more than you would like, ask your employer to add other low cost investment options, like index funds. These are mutual funds that passively track a stock market index, such as the S&P 500. The assets of an index fund change less frequently than the assets of a traditional mutual fund, so fund managers have less work to do and they can pass that savings on to you in the form of lower expense ratios.
3. The acquisition schedule
You should pay attention to the timing of your 401 (k) acquisition if your business matches some of your contributions. This determines when you can keep those employer matching funds if you decide to leave the business. If you quit your job before you are fully vested, you could lose some or all of your employer matching funds.
There are different types of acquisition schedules. Immediate vesting means your employer matched funds are yours as soon as you earn them. This type of acquisition is less common, but some companies that require employees to work for them for a certain number of months or years before signing up for the 401 (k) plan can use it.
Acquiring the Cliff is where you need to work for the company for a number of years before you can keep any of your employer’s matching funds. Quitting before you’ve worked long enough will cost you any employer matching funds you earned while you were there.
Gradual vesting gradually releases your employer-matched funds over time. If you have a five-year vesting schedule, you’ll keep 20% of your employer-matched funds if you leave the company after one year, 40% after two years, and so on.
You don’t have to worry about acquisition schedules if you’ve been working at your business for decades, but if you’ve only been working there for a few years and are considering quitting, it helps to understand the schedule for you. acquisition. Staying a few more months or even a year or two could make a big difference in your 401 (k) balance.
We’re only scratching the surface here. There is lots of rules on how 401 (k) works, how much you can contribute and when you can withdraw money. Understanding them can help you avoid costly mistakes and get the most out of your 401 (k). You can ask your plan administrator specific questions, but it helps to stay on top of any changes to the 401 (k) plan rules yourself so you can make the best choices.