A 401(k) plan may be established by a sole proprietor, partnership, corporation, and by certain non-profit organizations. Currently, state and local governments are prohibited from adopting a 401(k) plan.
The participant decides, based upon applicable plan provisions, how much money he or she wants deducted from their paycheck and invested during each pay period, up to the legal maximum established annually by the Internal Revenue Service (IRS). With a participant directed account you decide how to invest that money, choosing from your plan’s different investment options. The money you contribute to your 401(k) account is deducted from your pay either before income taxes are taken out (pretax contributions) or after income taxes are taken out (Roth contributions).
Pretax contributions are the amounts invested into your company retirement plan that are deducted from your paycheck before income taxes are calculated. By contributing to a 401(k), you can actually reduce the amount you pay in taxes each pay period. Pretax contributions help you lower your taxable income. Because of these tax advantages, the IRS puts certain restrictions on withdrawing this money before you reach age 59½. For example, if you earn $1,000 each paycheck, and you contribute 5% ($50), you are only taxed on $950. You don’t owe income taxes on the money until you withdraw it from the plan.
Roth contributions are the amounts invested into your company retirement plan that are deducted from your paycheck after income taxes are calculated. Roth contributions and their earnings can be distributed tax-free if you have a Qualified Roth Distribution (you have had your money in the Roth account for 5 years and you have reached age 59½, died, or become disabled).
Under current tax law, you may contribute $18,000 (limit for 2017). Thereafter, the limit will increase in increments of $500 for cost-of-living increases. Any previous contributions and your participation in other retirement plans may also affect your contribution limit. Of course, you must satisfy the plan’s eligibility requirements before you can defer. Certain non-discrimination rules may further limit deferral in some circumstances.
Current IRS guidelines allow an individual who will attain age 50 within the calendar year to make an additional pretax catch-up contribution if allowed by your plan provisions. For 2017, the additional catch-up amount is $6,000.
Once you have met your plan’s age and service requirements, your contributions are automatically deducted from your paycheck. Simply submit an enrollment form indicating a deferral percentage to your employer and your contributions will be deducted and added directly to your 401(k) retirement plan. Your plan may limit when deferrals may begin or how often they can be adjusted.
Department of Labor regulations require plan sponsors to submit employee contributions into the plan in a “timely manner” after they are deducted from the employee’s pay. The regulations provide that participant contributions to retirement plans become plan assets and must be deposited on the earliest day they can reasonably be segregated from the employer’s general assets. For small (less than 100 employees) employers, this is deemed to be seven days after payroll withholding. Failure to submit contributions in a timely manner may result in fines and other penalties.
Some companies offer a “match” or “matching contribution” as an incentive to participate in their retirement plan. It means that the company will contribute a certain amount to your account (usually between 25%–100%) for every percent that you contribute, up to a certain limit. The match formula can vary. To receive the matching contribution, the plan may require that you meet eligibility requirements. It makes good sense to take advantage of a company match by setting aside the maximum amount required to qualify for a matching contribution. If your employer offers a matching contribution, your savings can grow that much faster.
Depending on your plan, you may be eligible for a “hardship withdrawal.” According to IRS regulations, your hardship must represent an “immediate and heavy financial need” and there must not be “any other resource reasonably available to you to handle that financial need” (e.g., insurance, liquidation of assets, etc). The IRS recognizes six reasons for a hardship withdrawal:
Certain unreimbursable medical expenses
Purchase of a primary residence
Payments of post-secondary tuition for the next year
To prevent eviction from or foreclosure on your home
Payments needed to repair damage to your principal residence that would qualify as a deductible casualty expense
Payment of funeral expenses for your deceased parent, spouse, children or dependents.
Your account will be reduced by the amount of the loan. Over time you may miss out on the potential earnings that may have occurred as a result of a loss of your principal in your account. Even though you repay a loan to your account and continue to make contributions, you still lose the earnings potential for the amount of the loan while you are repaying it.
You will receive quarterly statements detailing your plan activity. You can also access your account information on our Web site. Online access allows you to monitor and make certain changes to your account, provides quick access to historical investment performance for your plan, and summarizes your plan provisions.
Not necessarily. Having a 401(k) will not reduce your Social Security benefits, but distributions from your 401(k) taken during retirement may make your Social Security benefits subject to federal income tax, especially if you have other significant income.
Generally, if you change jobs, you have four options available:
Transfer your money directly into an Individual Retirement Account (IRA)
Transfer your money into your new plan, if allowed by your new employer
You may be able to leave money in your current 401(k) plan if you have more than $5,000 invested in your account
You can take a full or partial withdrawal with the check payable to you and receive the funds directly, depending on the terms of your plan. You will owe income taxes on the withdrawal and you may also owe an additional 10% IRS early withdrawal penalty if the funds are withdrawn before you turn age 59½ (or age 55 if you have separated from service). In addition, other penalties may apply
All options are subject to your specific plan rules. You should work with your financial professional and tax advisor to determine the option which best suits your situation.
You must begin to take distributions no later than April 1 of the year following either the year in which you turn age 70½ or the year in which you retire, whichever is later. If you are a 5% owner, you must begin to take distributions no later than April 1 of the calendar year following the calendar year in which you attain age 70½.
This information is provided by Ameritas®, which is a marketing name for subsidiaries of Ameritas Mutual Holding Company, including, but not limited to: Ameritas Life Insurance Corp., 5900 O Street, Lincoln, Nebraska 68510; Ameritas Life Insurance Corp. of New York, (licensed in New York) 1350 Broadway, Suite 2201, New York, New York 10018; and Ameritas Investment Corp., member FINRA/SIPC. Each company is solely responsible for its own financial condition and contractual obligations.
Ameritas® does not provide tax or legal advice. Please consult your tax advisor or attorney regarding your situation.