401(k) Plans in Retirement Planning

Key strengths

  • You receive "free" money if your contributions are matched by your employer (subject to your plan's vesting schedule)

  • You decide how much to save (within federal limits) and how to invest your 401(k) money

  • Your regular 401(k) contributions are made with pre-tax dollars

  • Earnings accrue tax deferred until you start making withdrawals, usually after retirement

  • Your Roth 401(k) contributions (if your plan allows them) are made with after-tax dollars; there's no up-front tax benefit, but distributions of your contributions are tax free and, if you satisfy a five-year waiting period, distributions of earnings after age 59½ or upon your disability or death, are also tax free.

  • You may qualify for a partial income tax credit

  • Plan loans may be available to you

  • Hardship withdrawals may be available to you, though income tax and perhaps an early withdrawal penalty will apply

  • Your employer may provide full-service investment management

  • Savings in a 401(k) are generally exempt from creditor claims in bankruptcy (but not from IRS claims)

Bear in mind ...

  • 401(k)s do not promise future benefits; if your plan investments perform badly, you could suffer a financial loss

  • If you withdraw taxable funds prior to age 59½ you may have to pay a 10% early withdrawal penalty (in addition to ordinary income tax), unless an exception applies

  • The IRS limits the amount of money you can contribute to your 401(k)

  • Unless the plan is a SIMPLE 401(k) plan, a safe harbor 401(k) plan, or the plan contains a qualified automatic contribution arrangement (QACA), you may have to work for your employer up to six years to fully own employer matching contributions

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