401k how does it work

Remember that a k on its own is not a retirement income plan. A plan to create income in retirement will certainly take your k into consideration. But it should also include income withdrawals from other accounts like IRAs, Roth IRAs, investments, cash value built up within a whole life insurance policy and cash reserves. Your retirement plan will also include income from Social Security , and may include income from annuities and pensions.

By having multiple streams of income, you can more efficiently generate retirement income by strategically leaning on different sources at different times. This approach can help you minimize taxes while balancing the need to grow your investments and generate reliable income that will last through your retirement.

At this point, you can begin taking withdrawals technically known as distributions as you please. For many young earners who are just beginning their careers, lower income levels and tax brackets could make a Roth k a great choice. There is nothing forcing you to choose between either a traditional k or a Roth k —you can make contributions to both kinds of k plan, if your employer offers them.

Consider speaking with a tax professional or a financial advisor when deciding between a traditional or a Roth k , or dividing your contributions between both types.

Use Personal Capital's Retirement Planner to calculate how much you would need to save for your retirement. You decide how much of your income to contribute to a k account every year, subject to IRS limits.

You may halt contributions entirely at any time, for any reason. These limits apply to all k contributions, even if you split them between pre-tax and Roth contributions, or you have two employers in a year and thus two separate k accounts. In such cases, a combined employee and employer contribution limit applies. Unlike Roth contributions, these extra after-tax savings grow tax deferred, but not tax free. One common approach involves an employer matching employee contributions dollar-for-dollar up to a total amount equal to 3 percent of their salary.

Continuing our example from above, consider the impact on your k savings of a dollar-for-dollar employer match, up to 3 percent of your salary.

When starting a new job, find out whether your employer provides matching k contributions, and how much you need to contribute to maximize the match. Some employers grant k matching contributions that vest over time. If you were to leave the company and take a new job after two years, you would pass up owning half of the matching contributions pledged by your employer. Keep in mind, however, that you always maintain full ownership of contributions you have made to your k. You will usually have several investment options in your k plan.

The plan administrator provides participants with a selection of different mutual funds, index funds and sometimes even exchange traded funds ETFs to choose from. You get to decide how much of your k balance to invest in different funds.

You could opt to invest 70 percent of your contributions in an equity index fund, 20 percent in a bond index fund and 10 percent in a money market mutual fund, for example. Plans that automatically enroll workers almost always invest their contributions in what is known as a target-date fund. Generally, the younger you are, the higher the percentage of stocks. Even if you are automatically enrolled in a target-date fund, you are always free to change your investments. Investing options available in k plans vary widely.

You should consider consulting with a financial adviser to help you figure out the best investing strategy for you, based on your risk tolerance and long-term goals. Funds saved in a k are intended to provide you with income in retirement. Holders of both traditional k s and Roth k s are required to take RMDs. The amount of your RMDs is based on your age and the balance in your account.

As the name suggests, an RMD is a minimum—you can withdraw as much as you wish from the account each year, either in one lump sum or in a series of staggered withdrawals. Some of these include:. Oh, and if you're curious where the name k comes from? It comes directly from the section of the tax code that established this type of plan — specifically subsection k. A k plan is a benefit commonly offered by employers to ensure employees have dedicated retirement funds.

A set percentage the employee chooses is automatically taken out of each paycheck and invested in a k account. They are made up of investments usually stocks, bonds, mutual funds that the employee can pick themselves.

Depending on the details of the plan, the money invested may be tax-free and matching contributions may be made by the employer. If either of those benefits are included in your k plan, financial experts recommend contributing the maximum amount each year, or as close to it as you can manage. Shelter from creditors. In fact, let's dig into k benefits a little deeper.

Do you like free money? Good, now that we've got that out of the way, a company-matched k is basically that. Many employers offer to match employee contributions, either dollar for dollar or 50 cents to the dollar, up to a set limit. So, 3, free dollars. It's up to your employer to decide what percentage they will match, but many companies do offer a dollar-for-dollar match.

The tax benefits of ks are like the triple-crown of finances. First, contributions are pre-tax. At the earliest, this is age Second, your k contributions are not counted as income, which could put you in a lower tax bracket. The result: your tax bill will be smaller for your having squirreled away money for your later years. Third, your savings grow tax-deferred. In a regular investment account, your net gains and dividends would be taxed.