How Does a 401(k) Work?

If your company has a retirement savings plan, you might want to put money into it. But how does a 401(k) work? Find out how a 401(k) works and what the best ways are to keep your retirement savings plan in good shape below.

How Does a 401(k) Work?

When you put money into a 401(k) plan, the money comes out of your paycheck before taxes. So, if you put $100 into your 401(k) plan, you will have $100 less income that is taxed. The IRS puts a cap on how much money you can put into your 401(k) plan. The most you can give in 2022 is $20,500. If you are 50 or older, you can put in an extra $6,500 as a “catch-up” payment.

Your employer might match what you put into your 401(k) plan. With a matching contribution, your employer agrees to put some of the money you put into your 401(k) plan as well. For example, your employer may match 50% of the first 6% of your salary that you put into your 401(k) plan. The money you put into your 401(k) plan is invested in stocks, bonds, and mutual funds, among other things. Plans offer different ways to invest and charge different fees.

You don’t have to pay taxes on the money you put into your 401(k) or the money you make from your investments until you take the money out of your account. When you take the money out, you’ll have to pay income taxes on the amount. If you take the money out before you are 59 1/2, you may also have to pay a 10% early withdrawal penalty. Most withdrawals from a 401(k) plan are taken as a single lump sum. But, depending on your 401(k), you may also be able to take withdrawals as regular payments.

Remember, the tax breaks and matching contributions from your employer can make it a powerful way to save for retirement.

You can do a few things with your 401(k) plan if you quit your job. You can leave the money in your old employer’s plan, move the money to an IRA, or cash out the account. Most of the time, it’s not a good idea to cash out your 401(k) plan. You’ll have to pay taxes on the money you take out, and there may also be an early withdrawal penalty of 10%. Plus, you’ll miss out on the chance that your investments will grow over time.

Most of the time, it’s better to roll over your 401(k) into an IRA. With a rollover, you can move money from your 401(k) plan into an IRA without having to pay taxes on the money. And the money can keep growing without being taxed.

Best Practices for Healthy 401(k)

The 401(k) is a great way to save for retirement, but you need to keep it in good shape to get the most out of it. Here are some best practices and things to do to keep your retirement savings plan in good shape:

1. Make sure you’re doing enough to help. In 2022, the most you can put into your 401(k) is $20,500, so if you don’t put in at least that much, you could lose out on tax savings and growth.

2. Look over your investment mix to make sure it still fits your goals and how much risk you are willing to take. Your goals and willingness to take risks may change over time, so it’s important to check on your investments from time to time to make sure they still match up.

3. Keep your options open. Diversifying your portfolio is the key to lowering risk and getting the most money back. Make sure your retirement savings plan is spread out among different types of assets, industries, and countries.

4. Review your expenses. Many 401(k) plans have high fees and costs, which can cut into your returns. Make sure you know what you’re being charged and that it’s fair.

5. Keep an eye on how much money is in your account. As you get closer to retirement, you should make sure your account balance is where it should be. If it’s not, you may need to change how much you put in or how you invest.

By following these best practices, you can keep your 401(k) in good shape and on track to help you reach your retirement goals.