401k
A 401K is an investment and retirement savings plan offered by employers. Employees can choose to automatically take money from their paychecks and put it into a traditional 401K or Roth 401K. Employers can match contributions, and money for the Roth type is taken out after income taxes, and vice versa.
The 2022 yearly limit is $20,500 and $27,000 for people 50 years old or above. If you’re changing or losing jobs, roll over 401Ks into new ones of either kind or keep the old ones.
A 401K plan is one of the most popular ways that people who are employed use to save money for retirement. This type of plan is employer-sponsored, and it allows workers to direct a portion of their pay into an account that grows on a tax-deferred basis.
Later in life, seniors can use the money these accounts to provide retirement income. 401K plans are complex, though, and there are certain things for seniors to keep in mind in order to use them most effectively.
As we established earlier, a 401K is a type of employer-sponsored plan that individuals use to save money for retirement. To take part in their employer’s plan, an employee will show what percentage of their salary they would like to contribute. Many employers offer a contribution match, so for every dollar an employee saves, the employer will contribute the same amount–usually, up to a stated limit.
Employees also choose the type of plan they would like to use. Many employers offer traditional and Roth plans. In a traditional plan, contributions are pre-tax. This means that employees get to deduct their plan contributions from their taxable income in the year you make the contributions–saving on income taxes now. Later, when withdrawals are taken, they are fully taxable.
Roth plans work a little differently; contributions are not tax deductible, but, subject to certain limits, withdrawals after age 59 ½ are completely tax-free. So, the employee gets to decide whether they want to save on taxes now or later.
The next thing to consider is the available menu of investment options. The employer selects a type of bond, and the selection usually consists of mutual funds in stocks, bonds, or money markets. If the employer is a public company, they may also allow employees to allocate their contributions into company stock.
One of the most attractive features of a 401K is that earnings from the underlying investments accrue on a tax-deferred basis. Whether the investments grow in market value or pay dividends or interest, no taxes are due. The only way taxes are due is unless money is taken from the account.
A person’s employment status also contributes to how their plan works. Generally, if a person stops working for the employer who sponsors their plan, they can no longer contribute to that plan. They can, however, roll the proceeds of that plan into an individual retirement account (IRA), where they can keep contributing.
Later in life, when most people are seniors (or approaching that time), the focus may shift from growing retirement assets to drawing upon them as an income stream.
As with most financial matters, the best time to withdraw money from a 401K depends on a person’s individual situation. An important thing to remember is that withdrawals prior to age 59 are subject to a 10% IRS penalty plus the income tax.
There are a few scenarios in which the 10% penalty will be waived, though. These include disability, certain medical expenses, and distributions made to a beneficiary after the account owner passes away.
With this in mind, most seniors find it best to wait until age 59 at least to cash out. Another consideration is a person’s tax bracket. In a traditional plan, distributions are fully taxable at a person’s income tax rate. This is usually less of a consideration for Roth plans.
Another consideration is the performance of the assets in the account. When the market is doing well and there is a lot of gain in the account, it might be a good time to consider taking money out. Taking money out means that there might be some losses incurred.
This scenario played out for many seniors in the wake of the last financial crisis. Unfortunately, market risk is an unavoidable reality for seniors investing for retirement.
First, there is the early withdrawal method mentioned previously. Furthermore, if you are between 55 and 59 ½ years of age, the Rule of 55 can help you. If you lose your job for whatever reason, you can make a penalty-free withdrawal of any amount.
To qualify, withdraw from the account of the most recent company you worked at. And, if you start working again, you can continue penalty-free withdrawals only from that account.
The money will be taxed as usual. In addition, there is Rule 72 (t), which lets you withdraw penalty free, but again, the money is taxed as before. To qualify, you must meet SEPP regulations; you must take a minimum of five substantially equal periodic payments.
The IRS will calculate withdrawal amounts and a withdrawal schedule based on life expectancy. You must stick to the schedule for five years or until you turn age 59 ½, whichever one comes later. Lastly, this does not apply if you die or become disabled.
Another option for withdrawal is if you can qualify to take out a 401K loan. You can borrow up to 50% of the vested balance or $50,000, whichever amount is smaller. Furthermore, if you pay it back within five years, then you will not have to pay penalties or taxes.
And, in certain cases, for example when borrowing to purchase a home, the repayment period may be longer. But, if you part ways with your job, then you will have to pay penalties and taxes. To stop this, you must repay the loan. The usual time period is under a year to no later than the following year’s tax day.
Once you reach the age of 59 ½, you can make unlimited penalty-free withdrawals if you are retired. If you are still employed, then ask your plan administrator if withdrawals are penalty free. In addition, some plans offer in-service withdrawals that do not come with penalties.
Also, you can delay 401K withdrawls until age 72, because then the IRS will demand you take required minimum distributions. If you were born before July 1, 1949, then the specified age is 70 ½.
Lastly, withdrawals from a Roth 401K includes two qualifications. First, you must be at least 59 ½ years old. Second, your first contribution must have been made at least five years prior to the first withdrawal. For all the above situations, withdrawals are taxed as usual.
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