401(k)

Employer-sponsored personal pension savings account in the United States

A 401(k) plan is a tax-advantaged retirement account offered by many employers, allowing individuals to save for retirement through contributions deducted from their paychecks. There are two main types: traditional and Roth 401(k). In a traditional 401(k), contributions are made with pre-tax dollars, reducing taxable income, while in a Roth 401(k), contributions are made with after-tax dollars. Withdrawals from traditional accounts are taxed, whereas withdrawals from Roth accounts are tax-free. Employers may match part of the employee’s contributions, enhancing retirement savings. The maximum contribution for 2024 is $23,000 for most individuals and $30,500 for those over 50 years old. Early withdrawals before age 59½ may incur penalties and taxes. It’s advisable to consult with financial advisors before making any withdrawals.

Tax benefits of a 401(k)

The tax benefits of a 401(k) include the ability to deduct traditional 401(k) contributions from your tax return in the year you make them, lowering your taxable income for that year. Additionally, earnings within a 401(k) grow on a tax-deferred basis, meaning dividends and capital gains are not taxed until withdrawal. This tax advantage applies to traditional 401(k) plans, not Roth 401(k) plans. Contributions to a 401(k) are made with pre-tax dollars, reducing your taxable income for the current tax year and potentially leading to lower taxes during retirement. It’s important to follow rules such as avoiding early distributions before age 59½ and keeping contributions within the maximum limits set by the IRS to fully benefit from these tax advantages.

The difference between 401(k) and traditional IRA

A 401(k) and a traditional IRA are both retirement savings accounts with tax benefits, but they have key differences. A 401(k) is an employer-sponsored plan where employees can save a portion of their salary, often with employer matching contributions. Contributions to a traditional 401(k) are made with pre-tax dollars, reducing taxable income immediately, while withdrawals in retirement are taxed as ordinary income. On the other hand, a traditional IRA is an individual retirement account that you open and fund independently. Contributions to a traditional IRA may be tax-deductible, reducing taxable income, and withdrawals in retirement are taxed as ordinary income. One significant distinction is that a 401(k) has higher contribution limits compared to an IRA. Understanding these differences can help individuals make informed decisions about their retirement savings strategies.

What happens to my 401(k) if I leave my job

When you leave your job, your 401(k) will typically remain with your old employer-sponsored plan until you decide what to do with it. You have several options, including leaving it where it is if the account balance is not too small, rolling it over into your new employer’s plan (if available), transferring it to an individual retirement account (IRA), or taking some or all of the money out. Leaving your 401(k) with your old employer means you can no longer make contributions to the plan, but you can still manage the investments within the account. It’s essential to carefully consider the tax consequences and long-term implications before making a decision about your 401(k) after leaving a job.