401(k) Balance at Retirement
What is a 401(k)?
A 401(k) is a retirement plan offered by some employers. These plans allow you to contribute directly from your paycheck, so they’re an easy and effective way to save and invest for retirement. There are two main types of 401(k)s:
A traditional 401(k): This is the most common type of 401(k). Your contributions are made pre-tax, and they and your investment earnings grow tax-deferred. You’ll be taxed on distributions in retirement.
A Roth 401(k): About half of employers who offer a 401(k) offer this variation. Your contributions are made after taxes, but distributions in retirement are not taxed as income. That means your investment earnings grow federally tax-free.
Why should I use one?
Matching dollars, for one thing. Over 90% of employers that offer a 401(k) plan also kick in a matching contribution, which means as you contribute, your employer will, too. Commonly, that match will be worth 50% to 100% of your contributions, up to a limit that typically falls between 3% and 6% of your annual income. If your employer offers up this free money, you need to do everything you can to contribute enough to take advantage of it.
The other huge benefit of the 401(k) is that it allows you to put a lot of money away for retirement in a tax-advantaged way. The annual contribution limit is currently $18,000, with an extra $6,000 allowed as a catch-up contribution every year for participants age 50 or older.
What kind of investments are in a 401(k)?
401(k)s often offer a small, curated selection of mutual funds. That’s a good thing and a bad thing: On the plus side, you may have access to lower-cost versions of those specific funds, especially at very large companies that qualify for reduced pricing.
The negative is that even with discounted costs, that small selection narrows your investment options, and some of the funds offered may still have higher expense ratios than what you’d pay if you could shop among a longer list of options. That can make it harder to build a low-cost, diversified portfolio.
Some plans also charge administrative fees on top of fund expenses, which can add up. If your 401(k) is expensive, contribute enough to earn your matching dollars, and then direct any additional retirement savings contributions for the year into an IRA.
Anything else I should know?
Yep. A few things, actually.
Once you contribute to a 401(k), you should consider that money locked up for retirement. In general, distributions prior to age 59½ will be hit with a 10% penalty and income taxes.
If you leave a job, you can roll your 401(k) into an IRA at an online brokerage or robo-advisor. This can give you more control over your account and allow you to access a larger investment selection.
401(k)s typically force you to begin taking distributions — called required minimum distributions, or RMDs — at age 70½ or when you retire, whichever is later. You may be able to roll a Roth 401(k) into a Roth IRA to avoid RMDs.