401(k) plans — A popular way to save for retirement

As a component of benefits offered to employees, 401(k) plans are a very popular way to accumulate tax-deferred income and earnings for retirement.

Employers offer 401(k) plans as a way to help their employees save for retirement. You choose how much pre-tax income you wish to contribute and that amount is automatically deducted from your paycheck and placed into your account within the 401(k) plan. Your retirement savings can continue to grow tax-deferred until you make a withdrawal. You do not pay taxes on your salary deferrals or earnings until you take a withdrawal from the plan.

Generally, if you take the distribution after age 59½ there is no tax penalty. Distributions made after you've separated from service from that employer, if the separation occurred in or after the year you reached age 55, may also be made without an early withdrawal penalty.

Key Features

Because your employer sponsors the 401(k) plan, there may be other valuable benefits offered in addition to salary deferrals. Check your plan carefully. The following are key features provide a brief overview to assist you:

• Optional participation: Although some plan sponsors automatically enroll employees to promote plan participations, 401(k) plan participation is still optional. Check with your employer to determine how you can enroll.
• Contribution rate: You can choose the amount you want to contribute each payroll up to established IRS limits. You will also be permitted to change your contribution rate once you are in the plan.
• Available investments: You can choose from a variety of investment choices selected by your employer.
• Deferred taxes: Not only do your pre-tax contributions help lower your taxable income each pay period, but all earnings on your contributions grow tax deferred. Note: Some plans offer a Roth 401(k), which permit savings on an after tax basis. You will not be taxed on either the contributions or earnings until you make a withdrawal. Withdrawal are taxed as ordinary income in the year the money is distributed.
• Optional employer match: To provide an extra boost to retirement savings, many employers match a percentage of an employee’s contribution which will be given to the employee once she is vested.
• Accessing funds during employment:
  • Loans — as an optional feature your employer may permit you to borrow against your plan account up to specified IRS limits.
  • Hardship Withdrawals — Understanding that certain hardships arise, the IRS permits plans to allow distributions for certain hardship reasons.
• Portability: If you leave your job, you may be able to remain in the plan, or rollover your 401(k) funds into an IRA or another 401(k).
• Support: Your 401(k) plan provider typically offers many free tools and resources to help you establish savings goals, measure your progress, and to see how financially close you are to meeting your retirement goals.
• Higher contribution limits: The contribution limit in 2021 is $19,500 with an additional $6,500 catch-up contribution allowed for those age 50 or older.
• Roth account option: May also be offered by a plan sponsor under 401(k), 403(b), or governmental 457(b) plans. Roth contributions are made after you’ve paid taxes on the income, but qualified distributions may be taken tax-free in retirement.

Additional considerations

• You must be employed by a plan sponsor offering a 401(k) plan to participate. Check with your employer for their specific requirements.
• If you leave employment, you will no longer be able to contribute to the plan.
• Some employers will let you keep your savings in their plan after you leave.
• You can always combine all of your old plans into one rollover IRA or in most cases, into the 401(k) plan offered by your new employer.