Sounds complex, really simple: A 401K is a tax-deferred retirement plan offered by employers. That means that interest, dividends and capital gains accumulate tax-free until the investor cashes in. Below, we answer some of the most common questions about 401K plans, how they work and what happens if you withdraw funds from a 401K.
How many people contribute to a 401K?
According to the Census Bureau, 79 percent of Americans have the option to contribute to a 401K, but only 41 percent opt to contribute.
What is the average balance in a 401K?
It varies by age. Not surprisingly, those who are older have the most. People older than 65 average $216,720, while those between the ages of 25 and 34 average $26,839. Theresa Ghilarducci, a professor of economics and policy analysis at The New School for Social Research in New York, N.Y., said that the amount varies, but “I would shoot for 10 percent or 12 percent,” she added.
When do most people start contributing to a 401K?
Around four in 10 people begin contributing to a 410K in their 20s, according to a recent survey from Morning Consult. About a quarter began in their 30s and another quarter waited until their 40s. Some 8 percent start before age 20. Ghilarducci said it’s fine to wait until age 30 or so. “No, I think that’s good, especially if you have a 40-year career. That’s fine,” she said. “I mean, you’re better off if you start at [age] 10, but It’s OK to start around 30.”
What’s the difference between a standard 401(K) and a Roth 401(K)?
The basic difference is when you pay the taxes. With a Roth 401(K), you get the taxes taken out when you contribute. With a standard 401(K), your withdrawals are treated as income (you get taxed at 20% if you withdraw before 59 1/2).
When were 401(K) plans invented?
The 401(K) originated with the Revenue Act of 1978, which allowed participants to avoid being taxed on deferred compensation.
What is the most you can contribute?
For 2021, the annual contribution limit for workers 50 and younger is $19,500. Those 50 and older are allowed to add a “catch-up” contribution of $6,500 (which means they can contribute up to $26,000). The total amount contributed by you and your employer can’t exceed $64,500 per year.
Can you withdraw funds without being penalized?
Generally, no, but there are some exceptions.
1) Coronavirus-related exemptions; nearly 33 percent of Americans withdrew 401K funds (a study from Personal Capital says almost two-thirds of those who withdrew did so to cover basic living expenses).
2) If you are over age 55 and permanently leave your job, you can begin tapping it without incurring the 10 percent penalty.
An alternative is to contribute to a Roth IRA, which doesn’t levy such penalties (there is a 10% penalty on taxes on the income you earn if you are under 59 ½).
Can you withdraw funds before you turn 59 ½?
Under some circumstances, you can, but it’s generally not a good idea. That’s because you’ll suffer a 10 percent early withdrawal penalty and pay income taxes on the money. You’ll miss out on the money your account would have generated as well.
Can you borrow money from a 401(K)?
Yes, it’s possible to borrow against a 401(K). If the amount is fairly low and you intend to pay it back within a year, borrowing against your 401(K) can be a nice alternative to taking out a loan elsewhere. Receiving a loan from your 401(K) is not a taxable event and doesn’t impact your credit rating. It’s important to consider the overall state of the stock market when you are mulling this over, though. Such loans make more sense when the market is down than when the market is doing very well. The loans generally range up to $50,000 though during the pandemic, the federal government doubled that amount.