Adulting 101 Financial Planning Tax Policy

What’s in My 401(k): have you asked yourself these 5 questions?

Do you own a 401(k)? Well be sure to know the answer to these 5 questions.

A few weeks ago, we discussed the 5 ways young professionals can get started with retirement. Well, one of the best ways to begin your retirement planning is to contribute to a 401(K) plan.

Known for its origins in 1978, Section 401(k) of the Internal Revenue Code initially provided employees an opportunity to defer bonus or stock option related compensation. In 1981, the IRS passed rules allowing employees to contribute to 401(k)’s through salary and other related deductions.

As of Q1 2018, total assets in 401(k) plans totaled $5.3 Trillion in assets. However, the average balance per 401(k) is relatively alarming by age. For example, on average individuals from ages 30-39 had a balance of only $38,400. That’s alarming considering conventional wisdom suggests having $1.5 to $2 million to retire. The confusion and uncertainty surrounding 401(k)’s may account for hesitation on our part to contribute to our 401(k) plans.

1) Am I eligible to contribute?

The first step to establishing a 401(k) account is to verify your eligibility. Companies generally establish an age (21 and over) and service period (one year) in order for the employees to participate. Requirements can be more or less stringent depending on the plan, so reviewing the Summary Plan Description (SPD) or asking HR can be crucial.

2) What does my employer match?

The Summary Plan Description generally describes the employer match percentage. Additionally, this information is included on your company’s HR portal; sometimes, employer match can be a discretionary percentage depending on your company’s performance.

Consider that your company offers a match of 50% of your contributions up to 6% of your total salary. Assuming an annual salary of $50,000 and an employer contribution rate of 6%, the employer would match $1,500. How does that work? Take 6% of $50,000 and reduce it by half since the employer only matches 50%. Therefore, your 401(k) balance at the end of the year would be $4,500, leading to our next question.

3) Do I own the entire balance?

Generally, with 401(k) plans, there is a vesting period. Vesting refers to the ownership of your employer’s match contributions. Note, your contributions vest immediately upon contribution. However, employer match contributions may require certain years of service. Companies generally have a graded vesting schedule where the vesting percentage increases with the number of years of service. For example, 20% vesting after 0-2 years of service, 40% after 3-4, etc.

4) So, how do I invest in the plan?

Companies generally engage third parties to manage custodianship, trusteeship, and administration of the 401(k) plans. Usually, these third parties reach out to employees directly to set up their initial access to the plan’s individual account whereby you can direct investments that are available in the plan as negotiated by your employer.

Investment options may include target date funds (2050, 2060) or specific mutual funds and stocks for you to select. Be sure to carefully review investment performance, history of the fund, and expenses when selecting an investment option.

5) What about taxes?

Death, changes, and taxes – triple guarantees of life. Some employers will offer the option of pre (traditional) or post (Roth) tax contribution into the 401(k) plan. Traditional means that your contributions are deducted (pre-tax) before taxes are calculated on your compensation and vice-versa. Note, IRS sets annual limitations on contributions, which was $18,500 in 2018.


This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer. 
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