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Get the Most Out of Your 401(k) Retirement Plan

Get the Most Out of Your 401(k) Retirement Plan

Jenius Bank Team7/20/2023 • Updated 7/3/2024
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A 401(k) could help your retirement savings grow more over time.Saving for retirement is something most people strive to do, but according to a recent study conducted by the National Institute for Retirement Security, nearly 55% of working Americans fear they won’t have the financial security they need when they exit the workforce.1Taking advantage of a 401(k) plan through your workplace may help you build your savings and set yourself up for success. Even if you’ve contributed to your retirement account for years, you may not fully understand how it works or how to take advantage of the benefits these accounts offer. Here’s what you need to know about these retirement accounts as well as the steps you could take to maximize your savings and prepare for retirement long before you’re ready to exit the workforce.This information is not tax or investment advice. You should consult with a tax advisor and/or a qualified investment professional for advice specific to your particular circumstances.

Key Takeaways

  • 401(k)s could help you build your retirement savings more quickly through strategic investments.
  • These accounts are sponsored by employers and may be rolled over to a new 401(k) or IRA if you change employers.
  • Taking money from the account before turning 59 ½ could result in costly fees and penalties.

What Is a 401(k) and How Does It Work?

A 401(k) is an employer-sponsored retirement account that helps you build up your retirement savings. You’re able to contribute to it with each paycheck and invest those contributions into portfolios that could earn returns and grow your savings over time.Plans let you contribute a portion (usually a set percentage) of your income automatically from each paycheck. That percentage then goes into your 401(k) where it’s invested based on your chosen holdings and allocations.Your account’s growth is tied to the performance of those funds. The better the funds do, the more your account may grow. But there’s a downside, too. If the funds lose value, you may end up losing money.

Employer Contributions

401(k)s are different from Individual Retirement Accounts (IRAs) in that both you and your employer are able to contribute to the 401(k) account. Many companies offer matching contributions as part of your total compensation package, meaning they match a certain percentage or dollar amount of contributions you make to your 401(k) each year. These matching contributions may help you build your retirement savings faster by increasing the total amount of money hitting your account. For example, let’s say you’re 25 years old, making $100,000 annually, and starting to contribute 5% of your salary to a 401(k) each year. As the years go on, assume your salary is unchanged, you work continuously until retirement, and you continue contributing $5,000 per year to the account. With an average rate of return of 7%, you’d have approximately $1,068,048 saved by the time you retire at 65 years of age.2Now, if your employer were to match all of your contributions, the total annual contributions to your 401(k) account would be $10,000 instead of $5,000. With all the same assumptions, you’d have approximately $2,136,096 by the time you’re 65.3 That’s double the savings without reducing your take home pay! Again, this is a rough illustration of the potential benefit of matching. These numbers don’t consider any pay raises, increases in contributions, job changes, or taxes when you withdraw the funds. But the point is that getting your employer match could have a significant impact on your retirement savings.

Types of 401(k)s

The term 401(k) comes from the Internal Revenue code Section 401(k) which details the regulations that allow employees to defer paying tax on money set aside for retirement, otherwise known as “deferred compensation”.There are three main types of 401(k)s that you should know about.
  • Traditional 401(k): Traditional 401(k)s are what most employers offer. Your contributions are made on a pre-tax basis, meaning you won’t owe taxes on the earnings until you withdraw the money, which is why 401(k)s are tax-deferred accounts. Distributions are taxed as part of your income for the year you withdraw the funds. If you withdraw funds before meeting the minimum age requirement, currently 59 ½, you may be subject to an early withdrawal penalty.
  • Roth 401(k): Roth 401(k) accounts may also be offered through employers and use contributions that are made with after-tax dollars. The funds grow in your account on a tax-free basis since you’ve already paid tax on the money you contribute. You won’t owe income tax when you start taking distributions, and you won’t be subject to any penalties as long as you meet the withdrawal requirements of being at least 59 ½ (and the account is at least five years old).
  • SIMPLE 401(k): The SIMPLE 401(k) is a retirement account designed for small business owners with fewer employees. To qualify for these plans, employees must work for the employer for at least one year before opening an account. As with traditional 401(k) accounts, you pay taxes on distributions from your SIMPLE 401(k) and if you withdraw funds before turning 59 ½, you may have to pay a 10% penalty on what you withdraw.
All three are designed to help you save money for retirement while letting you take advantage of certain tax benefits. The type of 401(k) that you’re able to open largely depends on what your employer offers and what you qualify for. If given a choice between 401(k) types, the issue of tax obligations typically plays a major role in the decision-making process. Consult with a retirement specialist or a tax professional to determine which account type may be right for you.

401(k) Contribution Limits

There are limits to how much you’re able to contribute to a 401(k) account each year. These contribution limits are set by the IRS and usually change from year-to-year based on cost-of-living adjustments. Your employer’s contributions don’t count toward your individual contribution limit.In 2024, you’re able to contribute up to up to $23,000 to your 401(k) accounts. This means if you have a Roth 401(k) and a traditional 401(k), you can’t contribute more than $23,000 between the two accounts.4If you’re over the age of 50 and want to put more money away for retirement, in 2024 you may contribute an additional $7,500 in total to your 401(k) accounts.5

What Happens if You Contribute Too Much in a Year?

Overcontributing to your 401(k) is a tricky situation. It’s important to report an overcontribution quickly to limit your penalties.If you report your overage before taxes are due for the year, the amount you over-contribute is added to your taxable income for the year. You also have to pay a 10% early withdrawal penalty on the overage amount.6If you don’t report the overage until after you file taxes, the excess is counted as part of two tax years: the year the overage was made and the year it was distributed.7 In this scenario, you owe income tax on the amount twice – not the ideal outcome. To make sure you handle the situation correctly, contact your employer’s benefits manager for guidance.

How Do 401(k)s Grow?

Your 401(k) is invested into funds that you choose based on the investment funds your employer makes available through the plan. These funds are typically a mix of mutual funds, stocks, and bonds. Typically, you can change your asset allocation or fund selection through an online benefits or investment portal.

Can 401(k)s Lose Money?

It’s important to remember that 401(k)s are investment accounts. This means that, like any investment, there is risk. You as the account holder should determine how much risk you are comfortable with and allocate your 401(k) funds accordingly. If you’re a “high risk, high reward” type of person, you may choose funds that are oriented toward emerging technologies, for example. However, if the roller coaster of the stock market gives you heartburn, you may want to lean towards corporate and government bonds.Overall, your 401(k) should be considered a long-term investment: something you start early, contribute to throughout your career, and use in your retirement. Even with market downturns, many have found the 401(k) to be a good long-term strategy to help build wealth and create security for retirement. Check in with your investment advisor to choose the approach that fits best with you and your goals.

401(k) Withdrawal Rules

The point of a 401(k) is to help you save for retirement and the IRS expects you to leave your money in the account until you at least reach 59 ½ years of age or satisfy other criteria, like being unable to work due to a disability.8But that doesn’t mean you aren’t able to withdraw funds early. It just comes at a price.If you’re thinking of withdrawing money before you reach 59 ½, and don’t meet other criteria that would qualify you for a penalty-free withdrawal, you usually owe a 10% penalty tax each time you make a withdrawal.Another way to use your 401(k) is to take out a loan against its value. If you choose to take out a 401(k) loan, make sure you understand how the loan and the repayment work. And, of course, prior to repayment, those funds aren’t growing in your 401(k).

401(k)s and Job Changes

Since your employer sponsors your 401(k), it stands to reason that your account changes if you leave your current job. When you leave your job, you usually have a few options for managing your 401(k).
  • Leave it with your employer’s plan administrator: You may be able to leave your 401(k) with your former employer’s administrator, but you won’t be able to make contributions to that account. You could open a new 401(k) with your new employer and maintain both accounts.
  • Move it to your new employer’s plan: You could roll your old 401(k) into your new employer’s 401(k) plan without penalty. This allows you to make contributions to your new account and conveniently have your retirement savings in one place.
  • Roll it into an IRA: You may be able to roll your 401(k) into a traditional or Roth IRA. IRAs could be used in addition to an employer-sponsored 401(k) to further maximize your retirement savings. They tend to have more investment options than 401(k) plans.
  • Withdraw the money: You’re not required to roll your account into a new retirement savings account. You’re free to withdraw the full amount and use the funds as you see fit. Just remember that you may owe an early withdrawal penalty or additional taxes on your withdrawal depending on your age, the circumstances, and the account type.
If you’re not sure which method is best for your situation, consult with a financial advisor.

Final Thoughts

Opening a 401(k) may help you build your retirement savings and grow your wealth over time. Though these accounts have some limitations, they could be great options to help you start saving for retirement. Just be sure to keep contribution limits and age requirements in mind to help avoid paying penalties. 401(k)s are just one way to help build your wealth. Learn more about saving with a Jenius Bank’s high-yield savings account!
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