One of the first decisions you need to make when you’re hired at a new company is whether you’ll participate in the 401(k) plan. While participating in a 401(k) means more money coming out of your paycheck, it also means you’ll be building a nest egg for the future. The earlier you begin saving, the greater the effect of compound interest and the larger your savings can grow. Here are six things you should know about 401(k) plans before you get started, brought to you by Jan Gleisner, an investment advisor San Diego residents can rely on.
1. There Are Limits to How Much You Can Contribute
Because a 401(k) is a tax-preferred account, the IRS sets annual limits on how much you can contribute to your 401(k), and these limits are updated occasionally for inflation. For 2018, you can contribute up to $18,500 to your 401(k). The maximum contribution for “all sources,” which includes any employer contributions, is $55,000 for the year, which means you can receive up to $36,500 in matching and profit-sharing contributions. If you’re 50 or older, you can make additional contributions of $6,000.
2. Your Company Likely Offers a Match
One of the biggest benefits of a 401(k) is the opportunity to benefit from company matching. Many companies match a certain percentage of employee contributions. The most common employer match is 3-6 percent. To receive an employer match, you’ll need to contribute a certain percentage of your income. If you don’t contribute to your 401(k), you’re essentially leaving free money on the table.
3. Your 401(k) Can Be Rolled Over If You Change Jobs
401(k)s are different than IRAs because they don’t stay with you when you change employers. However, this doesn’t mean you need to or should cash out your 401(k) if you leave your job. When you leave the company, you can take a lump-sum distribution and pay IRS penalties, leave the money in the 401(k), roll it into an IRA, or roll it into your new employer’s 401(k) to continue enjoying the same benefits.
4. Your Employer May Enroll You Automatically
Many companies automatically enroll employees in a 401(k) plan, but you can also opt out. If you’re automatically enrolled, your contribution rate will probably be set at 3 percent of your salary. About half of the companies that do automatic 401(k) enrollments also use an auto-escalation feature that gradually raises the default contribution rate. You have the right to opt out of any contributions or raise or lower the contribution rate.
5. The Default Contribution Rate Probably Isn’t Enough
At the bare minimum, it’s important to at least contribute enough to your 401(k) to max out your employer match. If you rely solely on the default contribution rate set by your employer, you likely won’t be saving enough for retirement. Many experts recommend contributing 10-15 percent of your salary per year to your retirement account.
6. 401(k)s Offer Great Tax Breaks
A 401(k) is a defined-contribution plan that allows you to contribute pre-tax money from your salary into a retirement savings account. This type of tax-preferred plan allows you to directly lower your taxable income every year and reduce your tax bill every year you contribute. If you earn $3,500 before taxes and contribute $350 to your 401(k) per month, only $3150 of your monthly income is taxable. While your money stays in the account, it will also grow tax-free.
One of the most important financial moves any person can make is focusing on retirement planning. San Diego, CA, residents who need a trusted financial advisor can contact Jan Gleisner today at 858-337-2385.