When you started your job, you were probably presented with the opportunity to enroll in the company’s 401(k). Whether you’re completely new to the process or you’ve fallen behind, learn how to maximize your 401(k) for increased savings and better financial security in the future.
What is a 401(k)?
Simply put: a 401(k) is an employer-sponsored retirement saving and investing plan. It gives employees a tax break on the funds they contribute and allows them to defer the taxes on their investments until retirement. Many companies also contribute matching funds (free money) to encourage them to save.
Steps to Maximize Your 401(k)
So you’ve enrolled in your company’s 401(k) — now what? You don’t have to be a financial expert to get the most out of your plan, but it’s your responsibility to make sure you’re not leaving any money on the table. To get the most out of your plan, keep these five takeaways in mind.
1. Take advantage of your employer’s match.
Many companies match up to a certain percentage of an employee’s salary to encourage their employees to save. Know your company’s matching amount so you can take full advantage of these extra retirement funds.
For example, you might put 10% of your paycheck into your 401(k) and your employer might offer matching funds up to 4%. That means you’ll receive the full 4% from your employer as an investment into your 401(k). If you’re only contributing 3% of your salary, your employer will match only that 3%.
2. Stay until you are vested.
When you’re 100% vested in your 401(k), that means you own the plan or contributions to it. You’re immediately vested in your contributions, but it can take up to six years to become 100% vested in employer contributions. Leaving a job before you’re vested may result in only keeping a percentage of your employer’s contribution match. Worst case scenario: you may have to forfeit it.
Knowing when you’re fully vested not only helps you maximize your 401(k), but it can also help you plan career moves. For example, if you’re only one year away from being 100% vested in your 401(k) plan, you may want to stick around a little longer before taking another job.
3. Rollover without fees.
If you’re changing jobs and you’re not fully vested, you have two options. You can leave your balance at your former company, roll it over to an IRA or your new employer’s plan. If you want to move your money, ask your former employer to transfer the balance for you, instead of cutting a check. This helps avoid taxes and penalties. Chat with both HR departments involved about your options.
4. Know the tax advantages.
Any money you contribute to your 401(k) is pre-tax, meaning it’s taken out of your paycheck before taxes. When you contribute to your 401(k) you’re paying fewer taxes on your paychecks. Keep in mind that you’ll still pay taxes on whatever you withdraw during retirement. But saving on taxes now will help you work toward other financial goals, like paying off your credit cards.
5. Don’t cash out early.
Your 401(k) savings isn’t a savings account, so don’t use it that way. When you withdraw too early, you may pay a 10% penalty tax on top of any other withdrawal taxes.
You may be able to borrow from your plan via an interest loan, but remember that money won’t be earning interest in your investment account. Those interest rates are usually higher than the interest rate on the loan. So, even borrowing the money and paying it back can put a dent in your future retirement savings.
If you’re tempted to withdraw those funds, consider opening an emergency savings account. Dipping into your retirement account should always be a last resort.
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Allison Wheeler is a writer, Bruce Springsteen enthusiast, and sixth-generation Texan living in Denton, Texas.