What is a 401(k) plan?

A 401(k) plan is a type of retirement savings plan offered by many employers in the United States. It allows employees to save and invest a portion of their salary before taxes are taken out. These contributions and their investment earnings grow tax-deferred until they are withdrawn during retirement.

What is the difference between a Standard 401(k) and a Roth 401(k)?

The main difference between a Standard 401(k) and a Roth 401(k) is the way contributions and withdrawals are taxed. In a Standard 401(k), contributions are made pre-tax, meaning that they lower your taxable income in the year you contribute. Withdrawals during retirement are taxed as ordinary income. In a Roth 401(k), contributions are made after-tax, and withdrawals during retirement are generally tax-free.

Which 401(k) plan is better for me?

The choice between a Standard 401(k) and a Roth 401(k) depends on your individual financial situation and tax bracket. If you believe your tax rate will be higher during retirement than it is now, a Roth 401(k) may be more beneficial. However, if you expect your tax rate to be lower during retirement, a Standard 401(k) might be the better option.

Can I contribute to both a Standard 401(k) and a Roth 401(k)?

Yes, many employers that offer 401(k) plans allow employees to contribute to both a Standard 401(k) and a Roth 401(k). However, the combined contributions to both accounts must not exceed the annual IRS contribution limit, which is $19,500 for individuals under 50 and $26,000 for individuals 50 or older in 2021.

When can I withdraw from my 401(k) without penalty?

You can generally withdraw from your 401(k) without incurring a penalty when you reach age 59 and a half, regardless of whether it is a Standard or Roth 401(k). Additionally, there are certain exceptions to this rule, such as if you become permanently disabled, have significant medical expenses, or if your employer terminates the plan without offering a replacement.

401(k) (Standard vs. Roth)

By Charles Joseph | Editor

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A 401k is a retirement savings plan sponsored by an employer. It lets workers save and invest for retirement on a tax-deferred basis. Employees can contribute to their 401k through payroll deductions, and employers may match employee contributions up to a certain percentage.
it’s named for section 401(k) of the Internal Revenue Code, which governs its rules.

How Do 401(k) Plans Work?

401(k) plans are designed to encourage employees to save for retirement by allowing them to set aside a portion of their paycheck before taxes are deducted. The money that is set aside in the 401(k) plan can then be invested, and it grows tax-deferred until it’s withdrawn.

When an employee contributes to a 401(k) plan, they are typically able to choose how their money is invested. Common investment options include mutual funds, stocks, and bonds. Some 401(k) plans also offer annuities as an investment option.

Employees can usually start withdrawing money from their 401(k) plan when they reach age 59½ without having to pay a penalty. However, if withdrawals are made before age 59½, a 10% early withdrawal penalty may apply.

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In addition, once an employee reaches age 70½, they must start taking required minimum distributions (RMDs) from their 401(k). RMDs are calculated based on the account balance and life expectancy of the account holder and must be taken by December 31 each year.

Traditional 401(k) vs. Roth 401(k) [Video]

What Is a Traditional 401(k)?

A traditional 401(k) is a retirement savings plan that is sponsored by an employer and offers tax-deferred growth on investments. With a traditional 401(k), employees can choose to have a portion of their paycheck withheld and deposited into their 401(k) account. The money that is contributed to the account can then be invested, and it grows tax-deferred until it is withdrawn.

Traditional 401(k) plans are subject to annual contribution limits set by the IRS. For 2021, the contribution limit for employees is $19,500. Employers may also make contributions to their employees’ 401(k) accounts, but there are limits on how much they can contribute as well.

What Is a Roth 401(k)?

A Roth 401(k) is similar to a traditional 401(k), but with one key difference: contributions are made with after-tax dollars, which means that withdrawals in retirement are typically tax-free.

Like a traditional 401(k), a Roth 401(k) offers tax-deferred growth on investments and has annual contribution limits set by the IRS. For 2021, the contribution limit for employees is $19,500.

Employers may also make contributions to their employees’ Roth401 (K)’s, but there are limits on how much they can contribute as well.

Helpful Resource

A great resource to help you decide which 401(k) you should go with is the Traditional 401(K) Or Roth 401(K) Calculator.