Three 401k Rules You Should Follow
Your 401k plan allows you to save for your retirement. One of the main benefits of a 401k plan is that any investments into the plan are tax deferred, meaning that the earnings you pay into your plan are not taxed until they are later withdrawn.
What this means is that there are some rules which you have to adhere to when paying into and withdrawing from your 401k plan. Here are three 401k rules you should be aware of.
Contributing to your 401k plan
There is a maximum amount by law that you can pay into your 401k plan. The current annual limit is $16,500, meaning this is the maximum you can pay into your 401k plan each year if you are aged under 50.
If you turn 50 during the calendar year, you can make an additional ‘catch-up’ contribution of $5,000.
The only way that you are allowed to contribute to your 401k plan is through payroll deduction. Employers are also allowed to contribute to your 401k plan on your behalf and one of the benefits of a 401k plan is that many employers will match some or all of your contributions. For example, your employer may match your contributions by 50%. So, in that case, if you contribute $400 a month, your employer would contribute $200.
401k plan withdrawal rules
As your 401k contributions are tax deferred, you can’t just withdraw them at any time you wish. To withdraw from your 401k plan without being penalised, you must generally wait until you are 59 ½.
You may be able to make a 401k withdrawal after the age of 55 if:
- You become disabled
- You meet your employer’s hardship qualifications
If you withdraw from your 401k plan in other circumstances then you’ll generally pay a 10 per cent penalty plus income taxes on the amount that you withdraw.
If you are eligible to make a withdrawal, you can take a lump sum distribution minus a 20% IRS mandatory withholding amount. You can also withdraw the money to place it into another retirement account such as an IRA.
After you retire or you reach the age of 70 ½, you have to begin to take the required minimum distribution (RMD) from your 401k plan. If you don’t take out the RMD, you face a penalty from the IRS.
401k plan rollover rules
If you leave your job and go and work for a new employer you are allowed to do a ‘401k rollover’ into your new employer’s 401k plan. You can also do a rollover into another retirement account (such as an IRA). You generally have a certain amount of time in order to rollover your funds before you face a penalty for early withdrawal.
If you don’t have your 401k plan proceeds directly rolled over into your new account, and instead receive the withdrawal yourself, 20% of the withdrawal amount will be withheld. Even though part of your withdrawal is withheld, you must still deposit the full amount of previous 401k investment into a new account. That means you must come up with that 20% from somewhere else.
I’ve just started working for a new company who don’t match my 401k contributions. I thought they had to by law?
Julia – thanks for your question. No,companies don’t have to match your contribution and they have complete discretion as to whether or not they will. Any matching is a form of profit sharing. If your employer is not highly profitable, or if times are tough, they may choose to not match your contributions.
However, whether your company matches your contributions or not shouldn’t stop you contributing to a 401k plan.