Tip Sheet: Answers to Your Top 5 401(K) Questions
Q: Why is it called a 401(k)?
A: You can thank your federal government for creating such a non-descriptive name for a retirement savings plan. Subsection 401(k) is a part of the Internal Revenue Code (IRC) that was set into law in 1978. Just in case you’re wondering, a 403(b) and 457(b) are also named from their subsections in the tax laws. No wonder people get confused about retirement!
Q: What’s the difference between a traditional 401(k) and a Roth 401(k)?
A: The Roth 401(k) is relatively new, and both a traditional 401(k) and a Roth 401(k) are available through employers who offer this benefit. However, there are some clear differences:
•Traditional 401(k): employers can match your contributions, taxes are paid when money is taken out at retirement, it’s beneficial if your tax bracket will be lower in retirement, you can start taking money out at age 59 and a half, and minimum withdrawals are required at age 70 and a half.
• Roth 401(k): Employers can match contributions in a separate account that will be taxed as income when you take it out in retirement, and money is taxed before you invest it, but the earnings and withdrawals are tax-free in retirement — which is beneficial if your tax bracket will be higher in retirement. You can take money out at age 59 and a half and when account has been open five years. You can also roll over money to a Roth IRA to avoid withdrawal requirement at age 70 and a half.
Q: Where do I invest after I’ve maxed out my 401(k)?
A: Once you’ve contributed the allowable amounts to your workplace investing program, you don’t have to stop there. You still have options. Here are three investing vehicles to consider:
•Invest in a traditional or ROTH IRA.
•Convert old 401(k)s to ROTH IRAs.
•Put money into taxable investments.
Q: What can I do with my old 401(k)?
A: If you have an old 401(k) from a previous employer, you have four options:
• Leave your 401(k) at your old job (not always possible or a good idea).
•Transfer the money into your new employer’s plan (not always possible).
•Roll over the funds into an IRA.
•Cash out the 401(k) (don’t EVER do this!).
The first two options may not be available to you, and the fourth option is not an option, so mark it off the list. You’ll pay huge tax penalties and lose a chunk of that money. The best option, then, is to roll the funds into an IRA. And that’s easy to do.
Q: What do I do with my 401(k) if I lose my job?
A: If you have a 401(k) and you change employers for any reason, you have three basic choices:
• Do nothing. You could leave the money in the current plan if your former employer will allow it. It’s easy and convenient, but you may end up with higher fees than if you chose other options. And you can’t contribute to the account anymore.
•You can roll over your money into a new employer’s plan. There are limits and rules regarding this, so it’s not usually your best option.
• You can do a direct rollover into an IRA. Direct as in don’t each touch the money. If you have an existing IRA, you can roll your 401(k) balance into that. If not, you can open an IRA through a brokerage firm, a mutual fund company or your investing professional. Go to the one of your choice and ask them to contact your former employer’s 401(k) plan administrator and find out what hoops to jump through. You’ll fill out forms authorizing the transfer. You’ll also meet with the IRA provider to choose your investments for your IRA.
About Chris Hogan
Chris Hogan is the #1 national best-selling author of Retire Inspired: It’s Not an Age, It’s a Financial Number and host of the Retire Inspired podcast. A popular and dynamic speaker on the topics of personal finance, retirement and leadership, Hogan helps people across the country develop successful strategies to manage their money in both their personal lives and businesses. You can follow him on Twitter and Instagram at @ChrisHogan360 and online at chrishogan360.com or facebook.com/chrishogan360.