Getting the most out of your 401k plan

2006-05-10

In order to get the most out of your 401k retirement plan, the first thing you should do is to read through the company policy that governs the 401k retirement plans at your company. The different 401k retirement plans can vary greatly. A majority of the employers will offer you some type of matching, such as 2 percent or percent of your gross pay. Some companies have straight matching while others have 401k retirement plan systems that are more complex. It is not uncommon for companies to match your payments to the 401k retirement plan with 0,5 percent. This means that when you put in 4 percent of your pay to your 401k retirement plan, the company will match this with 2 percent. If you decide to pay more to your 401k retirement plan, such as 5 percent, the company will match this with 2.5 percent. This type of 401k retirement plans will usually come with a ceiling and you can therefore not get 10 percent from your employer by paying 20 percent to your 401k retirement plan. In order to get the most out of your 401k retirement plan you should always pay at least 5 percent if the “ceiling” is 2.5 percent, 6 percent if the ceiling is 3 percent and so on. By doing this, you will receive as much money as possible from your employer.

If you are currently in a low tax bracket, one way of getting the most out of your 401k plan is to set up a roth 401k plan. The roth 401k plan was introduced in order to provide individuals in low tax brackets with a beneficial 401k retirement plan. Most other 401k retirement plans will allow you tax deductions for the money that you deposit in your 401k retirement plan. With the roth 401k plan, your money will instead be taxed before your deposit them. The positive thing with a roth 401k plan is that, unlike the other types of 401k plans, you do not have to pay tax when you withdraw the money from your roth 401k plan. With other forms of 401k plans, the withdrawals will be treated like income and you will be required to pay standard income tax. Just like with the other 401k plans, you will not pay tax on the accumulating values with a roth 401k plan. A roth 401k plan can therefore be a good way of getting the most out of your 401k retirement plan if you think that you are in a lower income tax bracket today than when you retire.

In order to get the most out of your retirement plan you must also carefully decide what to do when changing from one employer to another. In such a situation, you will basically have four different options. You can let the assets stay in the old employer's retirement plan, you can cash out the money, you can make a 401k rollover to the new employer's retirement plan or perform a 401k rollover to an Individual Retirement Arrangement (IRA). Doing a 401k rollover is usually the best choice, since you most likely will have to pay administration fees for the account if your keep it with your old employer. Spreading your accounts over several employers is therefore not a good idea and making a 401k rollover every time you change employer will help keeping the fees down. Cashing out is also usually not recommended since you will be forced to pay a 10 percent penalty fee. Cashing out instead of making a 401k rollover will naturally also mean that you no longer have a retirement plan. If your perform a 401k rollover, the money will stay in a tax-deferred account for years or even decades until you retire and the money will most likely grow significantly which makes a 401k rollover financially wise in the long run.

Making a 401k rollover to the new employer is only possible if you have a new job waiting for you when you quite your old one. Always check the investment options available at your new work before deciding to do a 401k rollover. If you will spend some time between jobs or if you do not like the investment options available at your new workplace, a 401k rollover to an individual retirement account is the best choice. A 401k rollover to an individual retirement account will provide you with a larger control over the money. Making a 401k rollover to an IRA is also a good idea if your want to set up a retirement plan that you can stick to until you retire, regardless of how often you change employers. If you want to do a 401k rollover to an IRA, you need to fill out the IRS Form 1099-R. You will receive the money and must then make a 401k rollover within 60 days. When you have done the 401k rollover you must report this to the IRS using IRS Form 5498. You can only do 401k rollovers once every 12 months.

For more info on 401K plans and personal finance see our related articles below.

Related Articles:
» Benefits of opening an IRA
» Deferred Annuities and Your Retirement
» Roth IRA: What it is and how it works

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