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Understanding 401(k): Your Guide to Retirement Planning

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Learn about the basics of 401(k) plans, contribution limits, and more.

description: an image of a person holding a piggy bank with the words "retirement savings" on it, with a calculator and documents in the background.

A 401(k) is an employer-sponsored retirement-savings account into which a worker can divert some of their earnings from each paycheck on a pre-tax basis. This means that the money is not taxed until it is withdrawn from the account. A 401(k) plan gives employees a tax break on money they save for retirement.

401(k) plans are popular retirement savings options because they allow employees to save money for retirement while reducing their taxable income. Additionally, many employers offer matching contributions, which can help employees save even more.

When setting up a 401(k) plan, employees can choose how much to contribute from each paycheck, up to a certain limit set by the IRS. In 2021, the maximum contribution limit is $19,500 for those under 50 years old and $26,000 for those 50 and older.

A 401(k) match is money your employer contributes to your 401(k). This can be a percentage of your own contributions or a set amount. For example, an employer might match 50% of your contributions up to a certain amount.

One type of 401(k) plan is a Roth 401(k), which is an employer-sponsored investment account in which an employee contributes after-tax funds that may be withdrawn tax-free in retirement. This can be a good option for those who expect to be in a higher tax bracket in retirement.

Highly compensated employees (HCE) have special rules on contribution limits to their 401(k)s. Understand what an HCE is and the IRS rules to make sure you are contributing the right amount.

A money purchase plan is an employee retirement benefit plan that resembles a corporate profit-sharing program where the employer deposits a set amount of money into each employee's account each year.

401k vesting is the process by which an employee earns the right to keep employer contributions to their retirement account. Vesting schedules can vary by employer, but typically range from immediate vesting to a several-year schedule.

The SECURE Act 2.0 makes changes to the US employer retirement plan system with respect to both single employer plans and to “applicable plans,” which include 401(k)s. Some of the changes include allowing long-term, part-time employees to participate in 401(k) plans and increasing the age for required minimum distributions.

When considering a 401(k) plan, it's important to understand the investment options available. Some plans offer a limited number of investment options, while others offer a wide range of options. It's important to choose investments that match your risk tolerance and investment goals.

Another thing to consider when choosing a 401(k) plan is the fees associated with the plan. These can include administrative fees, investment fees, and more. Make sure to compare fees between different plans to choose the one that best suits your needs.

In addition to 401(k) plans, there are other retirement savings options available, such as Individual Retirement Accounts (IRAs) and pensions. It's important to consider all of your options and choose the plan that best suits your needs and goals.

Overall, a 401(k) plan can be a valuable tool for saving for retirement. By understanding the basics of these plans, contribution limits, investment options, and fees, you can make informed decisions and plan for a comfortable retirement.

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