401(k)-plan
A 401(k) plan is an employer-sponsored money-purchase retirement plan
What is a 401(k) Plan?
A 401(k) plan is a qualified retirement savings plan sponsored by many employers to their employees.
With this defined contribution plans you can save money without paying federal or state income taxes on your savings until you withdraw the money when you retire.
The taxable income of the vast majority of workers is lower when they retire than at the time they are working, so they enjoy considerable tax savings in retirement.
The employee can make contributions to their 401(k) accounts with a portion of wages to an individual account under the plan and employers may also make matching contributions.
How 401(k) plans work
There are 2 types of 401k plans basically differentiated by taxes:
- Traditional: employee contributions reduce their income taxes for the year they are made, but their withdrawals are taxed.
- Roth: employees make contributions with post-tax income but can make withdrawals tax-free.
An employer can have either type of account or both.
A 401(k) is a defined contribution plan where the employer and worker can make contributions between the limits set by Internal Revenue Service (IRS).
The difference with traditional pensions or defined benefit plan is the fact that the employer provide a specific amount of money when employee retires.
Employees should choose from particular investments into their 401(k) accounts between their employer offers. It's usually to find stocks and bond mutual funds.
401(k) Contribution Limits 2021
The maximum contribution limits to a 401(k) plan that employer and employee can make are related to inflation and it's calculated periodically.
The max contribution limits from 2020 and in 2021 depends on age:
- Under 50: $19,500
- 50 and up: $26,000
Employer Matching
If the employer matches the contribution or the employee contributes non-deductible taxes, the new limits are:
- Under 50 in 2021: $58,000, or 100% of employee compensation, whichever is lower.
- 50 and up in 2021: $64,500
Here you can see more clearly:
| Max Contributions limits from 2020 and 2021 | |||||
|---|---|---|---|---|---|
| Deductible contributions | Non-deductible contributions | ||||
| Under 50 | Over 50 | Under 50 | Over 50 | ||
| $19,500 | $26,000 | $58,000 | $64,500 | ||
Employers use a formula to calculate that match, for example 0.5 or $1 per dollar the employee contributes. Althougt this match will depend on the percentage of salary.
Traditional and Roth 401(k)
If the employer offers both possibility (traditional and Roth 401(k), the employee can put their money in both accounts until previous limits unless the employee had chosen tax upon withdrawal
401(k) Withdrawal Rules
It is important not to put all of your savings into a 401 (k) because it can be difficult to withdraw without penalties.
The earnings in traditional 401(k) is tax-deferred and tax-free in the case of Roths.
401(k) withdrawal age
To withdraw the plan, owners of both, traditional and Roth 401(k), must be over age 59½ or meet some criteria:
401(k) early withdrawal penalty
When an owner withdraws their money in a traditional 401(k) plan, that money is taxed as ordinary income. While Roth account owners will not be taxed if they meet some requirements.
401(k) hardship withdrawal
- Certain medical expenses
- Home-buying expenses for a principal residence
- Up to 12 months’ worth of tuition and fees
- Expenses to prevent being foreclosed on or evicted
- Burial or funeral expenses
- Certain expenses to repair casualty losses to a principal residence (such as losses from fires, earthquakes, or floods)