Back in the day, employers offered and funded employee pension plans to provide their employees with a steady income in retirement. Today, the pension plan has mostly disappeared. Instead, employers sponsor optional 401(k) plans that are funded by both employers and employees.
Security in retirement is now primarily the responsibility of the worker instead of the employer. As a result, only half of all workers are saving for retirement.
Contributions to a 401(k) plan are tax-deferred. They are automatically deducted from each paycheck before taxes are paid on the income. Taxes are paid when this money is withdrawn – ideally, in retirement.
A Roth 401(k) is a version that allows employees to make contributions with dollars that have already been taxed. The contributions grow tax free and are not taxed upon withdrawal.
Make Regular Contributions
An employee decides how much to contribute to a 401(k) out of each paycheck. Experts recommend contributing at least six percent of your paycheck each month, which is usually enough to qualify for an employer match. But this is just a minimum.
The Vanguard Center for Retirement Research recommends contributions of 9 to 12 percent for households with incomes below $50,000, 12 to 15 percent for incomes between $50,000 and $100,000, and 15 to 20 percent for incomes above $100,000. Employers rarely match for amounts over six percent.
The maximum amount that an employee can contribute to a 401(k) in 2013 is $17,500. Employees who are over age 50 can contribute an additional $5,500 to help them “catch up” as they near retirement. To maximize growth, taking withdrawals can be delayed until you are 70-1/2.
Avoid Early Withdrawals
Since they are designed to encourage saving for retirement, 401(k) plans include restrictions and penalties to discourage early withdrawals. If you withdraw your money before you are 59.5 years old, you will owe tax on the money, plus a ten percent penalty fee.
Despite these penalties, one in four households taps its 401(k) for needs unrelated to retirement – jeopardizing retirement security.
Federal regulations allow hardship withdrawals for specific reasons - primarily to avoid foreclosure or pay for medical expenses, a funeral or a college education. In addition, some plans allow employees to borrow from their accounts.
Take Care When Changing Jobs
The biggest cause of early withdrawal comes when an employee leaves a job and takes a check for the amount in a 401(k) instead of leaving money in the plan or rolling it over to an individual retirement account or the plan of a new employer. The person then pays taxes and a ten percent penalty.
Call an Employment Lawyer
The law surrounding participation in an employer-sponsored 401(k) retirement plan can be complicated, especially when faced with hardship or making a job change. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact an employment lawyer.