The Real Deal on 401(k) Plans: Busting the Myths and Unveiling the Truth


The Real Deal on 401(k) Plans: Busting the Myths and Unveiling the Truth

The internet is rife with misconceptions about 401(k) plans. To set the record straight: taking advantage of your company’s 401(k) plan is one of the smartest moves you can make on your road to millionaire status. Let’s dive deep into the essentials of 401(k) plans.

1. Contribution Options: Roth vs. Traditional

When you’re setting up your 401(k) plan, you’ll encounter two primary options:

  • Roth: Here, you contribute post-tax earnings. The perk? Your money grows tax-free and can be withdrawn without incurring any further taxes.
  • Traditional: This choice allows for an immediate tax deduction, with your funds enjoying tax-deferred growth. However, upon withdrawal in retirement, you’ll be taxed at your ordinary income rate. The decision between Roth and Traditional depends on individual circumstances and often requires more in-depth analysis.

2. Employer Match: Making the Most of Free Money

Many companies match the contributions their employees make to the 401(k) plan. For instance, if your company offers a 4% dollar-for-dollar match and you contribute $4,000 on a $100,000 salary, they’ll add another $4,000. But remember the vesting schedule:

  • Year 1 – 20% vested
  • Year 2 – 40% vested …
  • Year 5 – 100% vested

Note: The money you contribute is yours from day one, fully vested.

3. Contribution Limits for 2023

For employees:

  • Under 50: $22,500
  • 50 or older: $30,000

Including employer matches and profit sharing:

  • $66,000
  • $73,500 for those 50+

4. Investment Choices

Upon contribution, you’ll need to decide how to invest your funds. When choosing, keep these pointers in mind:

  • Not all target date funds are created equal.
  • Align your allocation with your age and risk tolerance.
  • Be wary of the expense ratios of funds.

Remember, there are advisors for 401(k) plans. Don’t hesitate to contact them for advice on investment allocation.

5. Exiting a Job? Here’s What You Can Do With Your 401(k)

  • Cash it out, but you’ll pay a 10% penalty plus income tax.
  • Roll it into an IRA, often offering more flexibility.
  • Leave it with your former employer.
  • Transfer it to your new employer’s 401(k) plan.

Some considerations:

  • IRAs typically have lower costs and offer more investment choices.
  • 401(k) plans allow penalty-free withdrawals from age 55 (compared to 59.5 for IRAs).
  • Exiting a qualified plan might mean less protection from creditors.

6. Unique Features of 401(k) Plans

  • Rule 72t allows for early withdrawal without penalties, given you take equal periodic payments.
  • Other exemptions to the 10% penalty include circumstances like death, disability, or medical expenses exceeding 7.5% of your Adjusted Gross Income (AGI).
  • Some plans permit tax-free loans up to $50k or 50% of the account balance.

7. Retirement Withdrawal Rules

  • You can start penalty-free withdrawals at 59.5 or 55 if you’ve left your job.
  • Funds grow tax-deferred until you reach the Required Minimum Distribution (RMD) age, currently at 72. By April 1 following the year you turn 72, you must start taking distributions (unless you’re still working).

8. Future Changes on the Horizon (Secure Act 2.0)

  • Employers will need to auto-enroll employees.
  • RMD age is set to increase from 72 to 73.
  • Catch-up contributions may rise to $10,000.
  • Eligibility requirements will be relaxed.
  • Provisions for student loan 401(k) matching are on the table.
  • Starting 2027, there will be a saver’s match for low-income individuals.

In conclusion, 401(k) plans are a powerful tool in your financial arsenal. While they might seem complex, with a bit of research and possibly some guidance, they can play a pivotal role in ensuring a comfortable retirement.