The 401k Savings Plan

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The Basics of 401k Savings Plan

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401k Contributions

While many factors influence the contribution rate to a 401K savings plan, these are not always related to financial well-being. For example, a person's planning horizon for retirement remains the most important variable. The shorter the time horizon, the lower the contribution rate will be. On the other hand, a person's education level and wealth may play a role. This article provides insight into the retirement plans of both employees and employers.

If you're under age 59 1/2, you may be able to make an early withdrawal of up to $22,500 tax-free.

401k Investments

The tax advantages associated with a 401K make it one of the best ways to save for retirement. Your employer may match a percentage of your contributions up to a certain amount. A common match is 50 percent of the first six percent of your pay. For example, if you make $35k and contribute six percent to your account, your employer will match fifty percent of that amount, making your total investment worth $3,000 or more. While a 50-percent return is difficult to find in today's economy, 401(k) investments are a sound way to go.


If you make $35k and contribute six percent to your account, your employer will match fifty percent of that amount, making your total investment worth $3,000 or more.


You can invest a portion of your account balance in individual stocks and bonds, or you can choose to invest in a mutual fund. Most 401(k) plans offer several different fund options. Most of these will allow you to choose from U.S. large-cap, small-cap, international, and emerging-market funds. Some plans offer alternative funds, such as real estate or natural resources. The percentage you invest in each will depend on your risk tolerance and how long you plan to save for retirement.

401k Withdrawal Penalties

If you're looking to take money out of your 401(k) account before you're 55, you'll be subject to a 10% early withdrawal penalty. If you're under age 59 1/2, you may be able to make an early withdrawal of up to $22,500 tax-free. The penalty will be based on the amount you have withdrawn, so if you take $10,000 from your 401(k) while you're under age 55, you'll owe $3,000. However, you can use this money for other purposes.

While early withdrawals of your 401(k) plan will still be subject to a 10% penalty, you may be able to obtain a hardship exemption by citing a medical emergency. In some cases, the early withdrawal penalty may be waived, such as for a first-time home purchase, or for a new build. Earlier this year, the CARES Act was passed and included several ways to help retirement savers get relief. RMDs were suspended for 2020, allowing individuals to defer taking distributions or return them to their retirement accounts. The CARES Act also relaxed rules for early distributions, including special withdrawal allowances for retirement savers. Nevertheless, in 2021, the 10% penalty will be reinstated.

401k Limits

The new rules for 401K and other retirement plans will increase the limits for annual contributions for those fifty and older. Starting in 2022, the limits will increase by another $1,000 to $20,500, and for people over 50, they will be able to add an additional $6,500 to their accounts each year. The limits will apply to most 401Ks and to 403(b) plans at nonprofit organizations. For more information on the limits, see the IRS website.

Combined contributions to a 401K plan can't exceed 25% of the eligible employee's compensation. However, catch-up contributions can be up to $63,500. For 2020 and 2021, the combined contribution limit for the two plans will be $58,000. Additionally, there are limits on contributions to SIMPLE 401(k) plans. While these limits may seem low, you should keep in mind that these amounts are only an approximate estimate, so it's wise to seek out a tax professional or accountant for more detailed information on what the maximum limits are.

401k Investment Options

Target-date funds have become very popular in 401K plans. These funds let investors choose a target date for retirement and then automatically rebalance as they near that date. As the target date gets closer, they adjust their asset allocation from aggressive to conservative. In addition, they take more money out of the stock market. Target-date funds are the way to go if you want to avoid the risk of market declines. Target-dated funds also allow investors to choose the amount of money they wish to keep in a 401K.

In addition to a 401K, some companies offer variable annuities as a supplemental investment option. This product is a hybrid between mutual funds and insurance protection. Because the time horizon for these products is longer, you can benefit from compounding earnings and recover losses. On the other hand, when you get closer to retirement, you may want to consider a portfolio that preserves capital and produces regular income. Listed below are some of the most popular investment options in the current market.


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