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What is a 401(k) Retirement Plan?

A 401(k) is an employer-sponsored retirement plan that allows employees to defer a portion of their wages to individual accounts. Generally, contributions to the plan are made on a pre-tax basis. However, some employer-sponsored plans allow for after-tax, or Roth 401(K) deferrals. Employers may also match their employees’ 401(K) deferrals up to a certain amount. Annual contributions are typically limited up to a maximum amount allowed by the IRS.

What Should I Do With My Old 401(k)?

When deciding what to do with an old 401(k), there are typically four options, each with pros and cons: leave the money in your existing 401(k), roll your 401(k) into your current employer’s plan, roll your 401(k) into an IRA, or take the cash. If you decide to leave the money in your existing 401(k), most of the time you will be allowed to keep the balance but leaving it in an old plan increases the risk of mismanaged funds, higher fees, or even the possibility of forgetting about it as you change jobs throughout your career.

Another option is to roll the 401(k) into your current employer’s plan. This is often an appealing choice, as it combines the retirement funds into one single account and can enable aging investors to avoid RMDs from an IRA. However, before taking this step, you must confirm that your new plan allows rollover contributions and make sure to thoroughly evaluate its investment options and fees.

An alternative path is to roll the 401(k) into an IRA, which tends to be relatively accessible, allow for consolidation of all previous or existing employer retirement accounts, provide the option of self-management, and tend to carry a broader selection of investment options. The disadvantages of IRA rollover include Required Minimum Distributions (RMDs) that begin at age 72 and the potential creation of additional tax liabilities if you choose to make any backdoor Roth IRA contributions.

Finally, there is always the option to withdraw the funds, but this is not advised for several reasons – for one, the funds taken from a traditional 401(k) will be subject to income taxes, meaning that you could be moved to a higher tax bracket if you withdraw a large amount. To make matters worse, withdrawing money from your 401(k) before age 59.5 results in an additional 10% early withdrawal penalty. All in all, it is crucial to evaluate each of these four options carefully before deciding what to do with your old 401(k).

What are the Benefits of a 401(k)?

There are many benefits of establishing a 401(k), perhaps the most obvious of which is saving to live comfortably in retirement. Employer sponsored retirement plans provide a fairly convenient way to save early and save as much as you can (while adhering to annual contribution limits), resulting in exponentially more savings when you reach your retirement age.

As an added benefit and incentive, many employers provide some kind of match, often in the form of a fixed percentage. It’s important to ensure that you’re contributing enough to get the full employer match, maximizing the savings available to you and not leaving any “free money” on the table.

There are many other benefits of having a 401(k) as well, like the variety of investment options and autonomy over contribution amounts, but more importantly, saving money in a 401(k) also reduces your taxable income and sets you up for even better financial preparedness down the road.

Can I Take Money Out of My 401(k)?

Because 401(k)s are built to encourage long-term participation, there is an early withdrawal penalty of usually about 10% on any money that is taken out before age 59.5. For this reason, it is typically not advisable to withdraw 401(k) funds before then, unless a true emergency arises.

Can I Have a 401(k) If I’m Self-Employed?

As a self-employed individual, the only kind of 401(k) you have access to is a one-participant (or solo) 401(k), which is available to business owners with no employees. This type of 401(k) offers similar benefits as an employer-sponsored one and tends to follow the same rules and regulations, with the main difference being that the participant is both “employer” and “employee.” 

There are several other retirement savings methods that can be utilized by self-employed individuals, including Traditional IRAs, Roth IRAs, and SEP IRAs. These distinct options can be explored further here.

 

Wealthspire Advisors is a registered investment adviser and subsidiary company of NFP Corp.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. ©2021 Wealthspire Advisors

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