Skip to main content

Your Complete Guide to 401(k) Retirement Accounts

Quick and Dirty Tips
  • Podcasts
    • Grammar Girl
    • Curious State
    • Get-Fit Guy
    • Money Girl
    • Project Parenthood
    • Relationship Doctor
    • Modern Mentor
    • Nutrition Diva
    • Savvy Psychologist
    • Who Knew?
    • Unknown History
    • Modern Manners Guy
  • Books
  • Categories
    • Health & Fitness
    • House & Home
    • Parenting
    • Relationships
    • Pets
    • Education
    • Tech
    • Productivity
    • Business & Career
    • Money & Finance
  • Offers
  • About QDT

What's Hot

How to Prepare for Your First Year of College

June 2, 2023

8 Ways to Cure a Hangover Fast

June 2, 2023

Should You Take Breaks from Working Out?

June 1, 2023
opens in a new window Facebook opens in a new window Twitter opens in a new window Instagram
Quick and Dirty Tips
  • Podcasts
    • Grammar Girl
    • Curious State
    • Get-Fit Guy
    • Money Girl
    • Project Parenthood
    • Relationship Doctor
    • Modern Mentor
    • Nutrition Diva
    • Savvy Psychologist
    • Who Knew?
    • Unknown History
    • Modern Manners Guy
  • Books
  • Categories
    • Health & Fitness
    • House & Home
    • Parenting
    • Relationships
    • Pets
    • Education
    • Tech
    • Productivity
    • Business & Career
    • Money & Finance
  • Offers
  • About QDT
opens in a new window Facebook opens in a new window Twitter opens in a new window Instagram opens in a new window Pinterest
Quick and Dirty Tips
You are at:Home » Your Complete Guide to 401(k) Retirement Accounts
Money Girl

Your Complete Guide to 401(k) Retirement Accounts

Confused about how 401(k)s work? Laura explains the rules for using these tax-advantaged retirement accounts, including employer matching, contribution limits, rollovers, withdrawals, loans, and more.

By Laura Adams, MBANovember 21, 2021No Comments8 Mins Read
opens in a new window Facebook opens in a new window Twitter opens in a new window Pinterest opens in a new window LinkedIn opens in a new window Tumblr opens in a new window Email
opens in a new window Apple Podcast Page opens in a new window Spotify Podcast Page opens in a new window Google Podcast Page opens in a new window Sticher Podcast Page
opens IMAGE file
Share
opens in a new window Facebook opens in a new window Twitter opens in a new window Pinterest opens in a new window WhatsApp opens in a new window Email

If you have the option to participate in a 401(k) at work or a solo 401(k) if you're self-employed, use these powerful investment vehicles to cut taxes and save more for a secure retirement. 

Most people know they should save for retirement; however, using a 401(k) may seem too overwhelming or complicated and prevent many from getting started. When I was in my 20s, I didn’t invest in my company’s 401(k) because I wasn’t sure what would happen if I left my job. Not understanding the retirement account rules held me back, and I don’t want that to happen to you.

While 401(k)s come with critical IRS regulations you should know, they’re not as tricky to master as you might think. If you’re lucky enough to work for an employer offering a 401(k), participating can be a powerful way to build wealth for retirement. 

In this guide, I’ll cover everything you need to know about 401(k)s, so you can accumulate a healthy nest egg and have a secure financial future.

What is a 401(k)?

In simple terms, a 401(k) is an employer-sponsored account for workers to save money for retirement. However, if you’re self-employed, you can have a solo 401(k).

The two main types are traditional and Roth. With a traditional 401(k), your employer (or you, if you’re self-employed with a solo 401(k)) deducts contributions from your paycheck before taxes get withheld and deposits them in your account. You defer paying tax on your deposits and investment earnings until you take 401(k) distributions in retirement.

If you don’t qualify for a Roth IRA because your income is too high, a Roth 401(k) or solo Roth 401(k) are great options because they have no income limits.

With a Roth 401(k), your employer deducts contributions from your paycheck on an after-tax basis and deposits them in your account. While you must pay tax upfront on contributions, your withdrawals of deposits and earnings in retirement are entirely tax-free.

What is 401(k) matching?

One of the most valuable benefits of participating in a 401(k) is that your employer may incentivize you by paying a match, which is free money. For instance, your company could match 100% or 50% of your contributions up to a specific limit. 

Let’s say you earn $50,000 a year and get a 50% employer match up to 6% of your salary. If you save $3,000 in your retirement account, your employer will deposit $1,500. That’s an instant 50% return on your investment. Not bad, right? 

Now let’s say you get the full $1,500 match year over year for the next 30 years. You’d have an extra $127,202 in your account to spend in retirement. And that’s a conservative estimate because it doesn’t account for potential increases in your wages.  

Vesting prevents you from owning matching funds until you’ve been employed for a set number of years. That means if you leave your job, you could forfeit some of all of your matching funds.

There’s one catch you should know about 401(k) matches: Some employers impose a opens in a new windowvesting schedule. Vesting prevents you from owning matching funds until you’ve been employed for a set number of years. That means if you leave your job, you could forfeit some of all of your matching funds. 

However, there’s never a vesting schedule for the contributions you make from your paycheck. You always own 100% of the funds you deposit in a 401(k) and can never lose them if you change jobs or get fired.  

What are the 401(k) contribution limits?

For 2022, you can contribute up to $20,500 to your 401(k), or up to $27,000 if you’re over age 50. These limits have been increased by $1,000 from 2021. 

Also, note that the annual contribution limit doesn’t include any employer matching. So, if you contribute $20,500 and your employer adds $2,500, it’s icing on the cake! 

Can you take 401(k) withdrawals?

Since the purpose of a 401(k) is to invest for retirement, there are rules against taking withdrawals before age 59½. If you tap into your 401(k) early, you typically must pay income tax plus a 10% early withdrawal penalty. 

However, there are penalty exceptions. For instance, the opens in a new windowRule of 55 says that you can take distributions penalty-free if you leave your job after age 55. That’s excellent news if you want to retire early. However, you still must pay income tax on withdrawals that weren’t previously taxed.

Additionally, you can skip the early withdrawal penalty for qualified hardships, such as becoming disabled, paying for education expenses, or avoiding foreclosure on your primary residence.

Once you reach age 72, you must begin taking required minimum distributions (RMDs) from a 401(k). The amount depends on the balance in your account and your life expectancy defined by IRS tables. RMDs that weren’t previously taxed get included in your taxable income.

Can you take 401(k) loans?

Another option to withdraw from your 401(k) is a loan—if your plan permits it. While it can be tempting to borrow from yourself, be sure you understand the following:

  • You typically must repay a 401(k) loan within five years.
  • Your 401(k) loan payments get deducted from your paychecks.
  • You must repay interest on 401(k) loans to make up for lost investment time.
  • You can’t take a 401(k) loan that exceeds $50,000 or 50% of your vested account balance, whichever is less.
  • You may get prohibited from making new contributions while repaying a 401(k) loan, leaving you unable to enjoy investing growth and employer matching.

What happens to a 401(k) if you leave a job?

If you leave your company, you can no longer make any new contributions to your old employer’s retirement plan. However, it’s easy to take your vested 401(k) balance with you. 

Here are five options you have for your 401(k) when leaving an employer:

  1. Cash it out.
  2. Leave it with your ex-employer. 
  3. Roll it over to an IRA.
  4. Roll it over to a 401(k) with a new employer.
  5. Roll it over to an account for the self-employed.

Most people choose to do an IRA rollover with their old 401(k) to have more control over their investment options and fees. But if you have a new job with a retirement plan or become self-employed, moving funds to a new 401(k) or solo 401(k) are also excellent options.

The worst option for an old 401(k) is cashing out because it’s an early withdrawal if you’re younger than 59½. You’d have to pay income tax plus the hefty 10% penalty, leaving you with significantly less money.

How to start investing in your 401(k)?

If your employer offers a 401(k), you may already be enrolled and not know it! Many companies auto-enroll new employees to encourage participation. You can review your last paycheck or contact your benefits administrator for more information.  

If you already have a 401(k), log on to your online portal to adjust your contribution amount, choose investments, and see your employer match. Most plans offer a diversified investment menu that includes mutual funds, exchange-traded funds, and money market funds. 

Target date funds are a mutual fund type that’s become popular in 401(k)s. They allow you to select a fund based on the date you expect to retire.

Target date funds are a mutual fund type that’s become popular in 401(k)s. They allow you to select a fund based on the date you expect to retire. Then the fund automatically adjusts its underlying investments to be more conservative as the date approaches. 

If you don’t understand your 401(k) investment choices or need help selecting appropriate funds for your financial objectives, speak with a financial advisor. Many 401(k)s offer free or low-cost guidance for plan participants.

Some 401(k) plans include auto-escalation, which automatically increases your contribution rate over time (such as 1% per year) until you hit a limit. That’s an excellent feature for slowly building your savings rate over time.

What are the advantages of a 401(k)?

Here are several pros for using a 401(k) to invest for retirement:

  • Many employers offer a 401(k) matching program that incentivizes you to save by making free contributions on your behalf. 
  • You reduce your tax bill by making traditional 401(k) contributions. 
  • You get tax-free withdrawal in retirement if you have a Roth 401(k).
  • You own your vested 401(k) funds and can take them with you when you leave a job.

What are the disadvantages of 401(k)s?

Here are a few cons for 401(k)s:

  • Not all employers offer a 401(k) retirement plan.
  • You typically can’t tap a 401(k) before age 59½ without paying an early withdrawal penalty.
  • You may pay higher investment fees compared to other types of retirement accounts, such as an IRA.
  • You may have fewer investment options than with an IRA (however, some might see that as a benefit). 

Use a opens in a new windowCompound Interest Calculator to see how much your 401(k) could grow!

What questions do you have about 401(k)s and other retirement accounts? Let me know by leaving me a voicemail at 302-364-0308. Want to keep in touch? Follow me on opens in a new windowInstagram or sign up for my weekly newsletter at opens in a new windowLauraDAdams.com.

Laura Adams, MBA
  • opens in a new window Facebook
  • opens in a new window Twitter
  • opens in a new window Pinterest

Laura Adams was named one of Empower's "Top 50 Women in Personal Finance" in 2018. She's one of the nation’s leading personal finance and small business authorities who works as an on-camera spokesperson, voice-over talent, and multimedia creator. She’s written multiple books, and the latest title, Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers, was an Amazon #1 New Release. As an award-winning author and host of the top-rated Money Girl podcast since 2008, millions of readers, listeners, and loyal fans benefit from her practical advice. Laura is a trusted source of practical financial advice for the national media, including TV, radio, digital, and print outlets. She’s been featured on most major network news outlets, Bloomberg, NPR, The New York Times, The Wall Street Journal, The Washington Post, Money, Time, Kiplinger’s, USA Today, US News, Forbes, Fortune, Consumer Reports, MSN, and many more. Her mission is to empower consumers to live healthy and prosperous lives by making the most of what they have, planning for the future, and making smart money decisions every day. Laura received an MBA from the University of Florida. She lives in Vero Beach, Florida, with her husband. Visit LauraDAdams.com to learn more.


Add A Comment

Comments are closed.

Don't Miss

How to Prepare for Your First Year of College

By JJ Watt, PartnerJune 2, 2023

Your first year of college is not only exciting, but quite transformative as well. It’s…

8 Ways to Cure a Hangover Fast

June 2, 2023

Should You Take Breaks from Working Out?

June 1, 2023

Think You’re Too Rich for a Roth IRA? Think Again

May 25, 2023

Stay In Touch

  • opens in a new window Facebook 12K
  • opens in a new window Twitter 25.7K
  • opens in a new window Pinterest 18.5K
  • opens in a new window Instagram 123K
  • opens in a new window YouTube 23K
  • opens in a new window Vimeo 11.2K

Our Picks

How to Prepare for Your First Year of College

By JJ Watt, PartnerJune 2, 2023

8 Ways to Cure a Hangover Fast

By Bruce and Jeanne LubinJune 2, 2023

Should You Take Breaks from Working Out?

By Kevin DonJune 1, 2023
opens in a new window Demo

Subscribe

opens in a new window Laura Adams, MBA for Apple Podcast Page opens in a new window Laura Adams, MBA for Spotify Podcast Page opens in a new window Laura Adams, MBA for Google Podcast Page opens in a new window Laura Adams, MBA for Sticher Podcast Page opens in a new window Amazon Play Podcast Page

Books

Money Girl
opens in a new windowMoney Girl image for Amazon.com opens in a new windowMoney Girl image for Barnes and Noble opens in a new windowMoney Girl image for IndiBOund opens in a new windowMoney Girl image for  Apple iBookstore
Money Girl
opens in a new windowMoney Girl image for Amazon.com opens in a new windowMoney Girl image for Barnes and Noble opens in a new windowMoney Girl image for  Apple iBookstore

Don't miss

Never miss another tip! Join our list to get updates from your favorite hosts delivered straight to your inbox
Sign Up

ABOUT US

logo-img

Whether you want to manage your money better, rock your professional life, stay fit and eat healthy, or discover the keys to better mental health, Quick and Dirty Tips delivers short-form podcasts and articles every week to keep you at the top of your game, usually in ten minutes or less!

Email: contact@quickanddirtytips.comcreate new email

QUICK LINKS

  • opens in a new windowHealth & Fitness
  • opens in a new windowHouse & Home
  • opens in a new windowParenting
  • opens in a new windowRelationships
  • opens in a new windowPets
  • opens in a new windowEducation
  • opens in a new windowTech
  • opens in a new windowProductivity
  • opens in a new windowBusiness & Career
  • opens in a new windowMoney & Finance
  • opens in a new windowHow to listen
  • opens in a new windowPrivacy notice
  • opens in a new windowAds & Cookies
  • opens in a new windowTerms of Use
  • opens in a new windowAbout QDT
  • opens in a new windowOur Hosts

OUR PICKS

How to Prepare for Your First Year of College

June 2, 2023

8 Ways to Cure a Hangover Fast

June 2, 2023

Should You Take Breaks from Working Out?

June 1, 2023
opens in a new window Facebook opens in a new window Twitter opens in a new window Instagram
Copyright © 2023 Macmillan Publishing Group, LLC. Quick & Dirty Tips™ and related trademarks appearing on this website are the property of Mignon Fogarty, Inc. and Macmillan Publishing Group, LLC.

Type above and press Enter to search. Press Esc to cancel.