A 401(k) can be a great vehicle for retirement savings. So it’s important to understand how to set one up and how they work. It’s also important to make sure you’re eligible for your workplace’s 401(k) and have a Plan B if not so you are still able to save for your future.
Why 401(k) accounts?
A 401(k) is a very common type of employer-sponsored retirement plan that’s available to all employees who meet certain criteria. The criteria are the employee must be 21 or older and have completed at least one year of service with the employer, usually defined as 1,000 work hours in a plan year. Some employers allow new employees to join right away, even if they haven’t met these criteria yet.
In 2020, you’re allowed to contribute up to $19,500 to a 401(k) or up to $26,000 if you’re 50 or older. These limits are higher than what you find with IRAs, and they enable you to set aside a fairly large sum on an annual basis.
Most 401(k)s are tax-deferred, so your contributions reduce your taxable income each year. You must pay taxes on the distributions you receive in retirement, but you may be in a lower tax bracket by then, in which case you would save money. Some employers also offer Roth 401(k)s. You pay taxes on contributions to these accounts now, but distributions in retirement are tax-free.