Can anyone help me to better understand how 401K works?

My company automatically puts in 4% of my pay, and matches it.
They match up to 4%.
I'm putting in 4%, so are they matching what I put in, or just 4% of the 4% I put in?
Never really payed much attention to it as they just started doing this a few years ago.
I'm thinking of upping the contribution to 10% or 15% as I need to do something other than just put it into a savings.

They probably are matching what you put in, dollar for dollar, up to 4% of your salary or wages.

Remember the cardinal rule of investing - don't put all your funds in any single basket. In addition to your work 401k you might want to talk with a financial advisor about other options. If you are maxed out at 4% matching, put in the full 4%, and whatever else you may do, you still have the advantage of their match.

M29 said a mouthful. Most of all don't forget the hefty tax bite you will take on it if you have to take anything out of prior to your retirement.
I would definitely think about other things like CD's or IRA'S or maybe just some other investments that you could move around or maybe even dump if they look like they are sliding to far down the hill.

Upping your contribution can also help lower your taxable income if you find yourself owing or have few deductions.

The only part that concerns me is what's the tax rate likely to be when it's time to start taking it.

The gomment it broke and they might go after some of that baby boomer cash in the near future.

So like the other guy said, spread it around a little.

WE have a 5% match. One percent is automatic from the employer (Feds) and the next 4 is a match for my contribution. We put in 13% plus $200 per month to make up for my military time. We have a "plan" that maximizes your investments geared towards your expected retirement date (2020 in my case). Right now, since I've about 4 years to go, the investments are mostly geared towards safety (i.e. bonds). One advantage is that we can borrow from ourselves: we can take money out (for a $50 fee) and pay it back into our account. All payments, including interest, go back into our
401k. As long as it is paid off by retirement (or whatever the loan terms are), we don't pay taxes on it until we retire.

Currently, Federal employees have FERS: a mix of 401k, Social Security and a pension.

If you are maxed out on your company matching funding, you might want to look at a Roth IRA. In any case, advice from a certified, qualified financial adviser should be the highest propriety on your agenda. Just bear in mind, all financial advisers are not created equal. Regardless of what they tell you, their highest priority is to make money for themselves (or their company). That said, the information they provide you can be invaluable, and you don't have to invest with them if you don't want to.

401's are good....up to a point....

I maxed out my contributions to my 401 when I was working...That's fine..I got a nice bundle..BUT...Now that I'm retired. and I have a pretty good retirement income, not counting the 401...But when I want to take out say $10,000 per year, and that keeps me in the upper income bracket, I get the Holy )&*)(*&(&^ taxed out my total incomes for the year...No deductions, house I is no help any more to off set the income.

Consider how the 401K was originally set up...In my opinion, they had this figured out from the beginning.

A 30 year old starts to save, for say 30 years...The person had bought a house and after 30 years had it paid off. So there is no more mortgage deductions to be taken...The any money taken from the 401 is added to a persons total income for the year..(Me) That amounts to a total income, and no deductions, so that keeps a person in the higher tax bracket, and thus pays higher income taxes for the year.

If I had to do it over again, I would have paid more into a Roth account...or buy some dollar cost averaging and bought some stocks out right. Especially some good paying dividend stocks. Pay the taxes on the money up front.

What for you to do now???? Some of your 401 can be rolled over into a Roth now, but you may still get caught up in paying the taxes now from your 401 withdrawal....

Yep, this is one you might be best on consulting with a good financial advisor...CAUTION>>>>Make sure it's a certified consultant, and not someone who may not have your best interests at hand.




WuzzFuzz

All I can offer is save something every payday, keep your debt load as low as possible, and watch your impulse purchases. This last one used to kill me, and it still can if I'm not careful.

There is an annual limit, upped by $5/6Kfor older workers. An important thing is to balance the monthly amount to be sure that you get all the available match EACH MONTH. Don't load up so that you've contributed the max in October, and lose the match for a month or two.

As well, sit down with the tax tables and see what the right % is. I sat with an employee who had no clue that the payroll tax could easily change a lot for a very small contribution amount. I've seen adding a 1% contribution reduce tax deductions such that the take-home went up.

Also, get info on how to access the investments page, so that you can set what amount of money goes to what type of investment. I would expect you to have several fund options. Some are better than others, so you have to do the research.

There are many websites which explain exactly how 401k and Roth IRAs work. Even the IRS has publications. Your employer's human resources department should also be able to explain your 401k plan fully. In general, an employer-matching 401k is a good deal, as the employer matching part is essentially a gift to you. Generally, the employer match is dollar-for-dollar up to 5%. Your contribution could be somewhat higher than 5%, but not matched. That money is not taxed until you withdraw it, then it is taxed like regular income. Early 401k withdrawals in most cases (there are exceptions) carry a substantial tax penalty. Also, you must start taking withdrawals in the year you turn 70-1/2. There is an IRS schedule for that.

You can also contribute to a Roth IRA in addition to the 401k. Difference is, your Roth contributions are made with after-tax money and have lower annual limits on contributions. But there is no tax on withdrawals, and there is no requirement to start making withdrawals at 70-1/2. IRS publications are a good source of information. You will normally set up an IRA account through an intermediary, such as a stockbroker, it's a very simple process, and you can invest the funds in your Roth IRA in any way you want. You can roll-over a 401k into a Roth IRA, but of course, doing so is treated as a taxable withdrawal from your 401k. There are sometimes advantages to doing that.

Just read up on it, or talk to your HR person or a stockbroker.

I retired in 2003 and had been in a 401k for almost 25 years. When I began contributions my company also contributed $1.00 for every $3 I put in. I was taking out 15% of my check every payday. I didn't pay any attention to how my money was being invested and at the time could care less. I just figured I would be rolling in cash within a few years. On one annual statement my balanced had decreased over $4000.00. I called up my HR department and wondered what happened to my money. They explained that since the stock market had taken some big looses, so did my money. I just couldn't understand that excuse.

It was then that I started paying attention to where my money was going. I read a lot of books and was lucky to find an excellent financial adviser who helped me position my investments in various 401k accounts. I doubled my balance the first year and it kept going up from there.

My advice is to know where your money is being invested and take a pro-active stance on managing your account. Who ever your company is using to manage your 401k should have financial advisers available to you.

Money put into a 401k doesn't just grow by itself. You need to know where its invested; Stocks, Bonds, Money Market Accounts, Mutual Funds, etc. 401k's aren't risk free and losses are not that uncommon, especially in today's shaky economy.

My last employer (I get squat now) did a 6% match. I learned late into my 8 year career I could put 25%. I was putting in a total of 31% of a six figure income in and the only effect was lowering my take-home by $100/wk or so. Max it, now. Joe

A real life example. At the sub-contractor job I had when I was younger, my employer had an unusually generous 401k match. I had the maximum 20% deducted, and it only reduced my take-home pay by about 10%. The employer contributed another 10%. So, my retirement fund was growing at a rate of 30%, which made it build up really fast, and it was only reducing my lifestyle by 10%.

Of course, the IRS is now getting some revenge every April 15...

The second part of the IRA equation is how the money in your account is invested. Normally, you will have some control over that. The typical advice is to use some mixture of fixed income and equity investments, normally done by purchase of indexed mutual funds or exchange-traded funds tracking various indexes. You can buy or sell such investments as you wish without tax consequences, so long as no funds are removed from the IRA. If you are unfamiliar with investing, your best bet would be to speak with a stockbroker and also do some research on your own through the internet. There is a truly vast quantity of investment information available on the internet.

Look into a Roth 401K. deposit money you've already been taxed on. no taxes on withdrawals at retirement time.

DWalt said:

The second part of the IRA equation is how the money in your account is invested. Normally, you will have some control over that.

Click to expand...

That's the second issue, the IRA. I rolled my 401k into an IRA, using the same financial adviser. Up until a month ago it was doing great. Now it up and down with the stock market.

The gotcha is that when you turn 70 1/2 the IRS requires that you begin taking out a minimum distribution each year, which with a conventional IRA is taxable. It also adds to your annual gross income, so if you take out too much at one time it will put you into a higher tax bracket, thereby raising your tax liability.

So I have money in the bank that I can't use as I wish, otherwise I pay more to Uncle Sam. There is no free lunch, they gotcha any way you try to turn. Still better than having saved nothing at all.

A Roth IRA and a 401k are two completely different animals. You can, and probably should, have both.

A standard 401k is a tax advantaged retirement account. Most companies have a menu of mutual funds that the money can be invested in, some allow you to pick individual stocks also.

It is tax advantaged, in that no income tax is collected on money that is contributed, and earnings continue to grow tax free. You may not withdraw until you are age 59.5 without paying a penalty. Withdrawals are taxed at whatever the full income tax rate is at the time. This is important: it is NOT a tax free account, it is tax DEFERRED.

If you have access to a Roth 401k (similar to a Roth IRA), contributions are NOT tax deferred (you pay tax now), but earnings are tax free, and later withdrawals are also tax free.

I did not have access to a Roth 401k, so I maxed out my regular 401k. In hindsight, I think I made a mistake. My reasoning:

Income taxes will never be lower than they are now in my lifetime. With debt at over 100% of GNP, Social Security and Medicare going bust, taxes will only go up in the future. So I deferred my taxes from low tax rate past/present, to a probably much higher tax rate future. It I had a Roth 401k, that would have been a much better investment.

I have invested on my own also, and should have done more. My own investments were made with after-tax money. Taxes on Dividends and capital gains are at a much lower rate. Using current top rates, future 401k withdrawals can be taxed at the 39.6% ordinary income rate, dividend and capital gains income from my own investments will taxed at a top rate of 20%.

Essentially earnings in 401k accounts are being over-taxed - they are getting hit with the full ordinary income tax rate instead of the more advantageous capital gain rate that would have otherwise been paid. In the long run, the portion of the account due to earnings will be far greater than the actual contributions, so this future over-taxation is a huge hit.

If I could do it over, I would put the minimum necessary to get the full company match preferably in a Roth 401k, otherwise a regular 401k. I would then invest the rest on my own.

Investing on your own requires work. You must pay attention to financial news, research companies, and understand what you are doing. Savings accounts and money market funds will not do it.

401k is merely a sub-section of the Internal Revenue Code. 401K plans started around 1978. It is NOT magic; but,...it IS perhaps, the ONLY, REASONABLE, advantage/ break, a wage earner,(working stiff), has ever been allowed by the IRS !

Many of it's intricate regs. and rules have been pointed out, and, first and foremost O P, your "4 %" question was answered.

A company that has a "401K" plan is doing both of you a favor. Them, because they no longer have to offer a "defined pension plan" in order to attract first rate help.
You; because the amount of contribution you make is, first of all, deducted from your April 15 tax burden. The company also is only required to make their portion of the contribution quarterly, so smaller companies have some operating capital that uncle sam stays out of.

The rule once was, a company must have nine full time employees, (that participate) in order to have a 401K plan. That may be changed now.

If a company, (not all do anymore), matches any portion of your contribution, that is "gravy". It earns the same as your contribution, going tax free until you have to begin taking a " R M D" in the year you turn 70 1/2.

The idea was, most people by the age of 70 1/2 would no longer be high earners, and would be at the lowest tax-rate of their lives, so RMD withdrawals, which are taxed as ordinary earned income would be a bargain, compared to the tax-rate you would have paid at peak earnings years.

A caution here. If you decide to NOT take any or all of the "RMD", there is a 50% penalty on the un-taken amount.
As pointed out by several here, some people, have managed to be earning more taxable income at 70 1/2 than ever before, thus, the advantage of the 401K seems to be lessened.

Not So..... The many years of lowered tax burdens have to be taken into account. The "flaw" of 401K as I see it, (the only one ! ) has to do with the ever rising age of full retirement Social Security age. While at the old age grouping of 65, you had 5 1/2 years before RMD. Now it is about 3 1/2 or 4.

Granted, for a worker with V P behind their name, a six-line phone system on their desk, internet access, and some of the "on job personal time" allowed by those arrangements, certainly there could be a higher return investment portfolio.
But, by and large, my advice would be two-fold. Make the largest contribution you can, and keep at least half your plan choices in a stable fund. Right now; perhaps more than half.

I will add, that most every one notes the 59 1/2 age as the point you can begin to withdraw with no penalty.
Most all plans now allow several situations where you can take some of your money and pay it back to the plan with a minimal "make-up" percentage of 1 or 2 percent, over and above the agreed upon "pay-back" amount for handling fees and such.
This ""fee" will not be added to the grand total of your 401K.

Also, major medical problems, first time home buyers, and college funds for your offspring,(or you), all can be taken with no penalty. Normal earned income taxes yes, but no further penalty.

One little oddity hardly ever mentioned. IF, you note ANYONE other than your spouse as a beneficiary, they, the spouse, must agree in writing.
This may have changed in recent years, seeing as the whole concept of "spouse" has changed, but some states have special consideration for "spouses" in regards to a 401K plan. (We now head into "inheritance land", which is more mysterious than 401K.

Finally, while 59 1/2 is considered the age when 401K / IRA money can be taken with no penalty, actually, you can start taking 401K plan money at age 55; provided you declare full retirement, and state an EXACT amount per month,(every month till age 59 1/2) you wish to take.

If the amount is too little to live on; tough. If it turns out to be an overage ? well you can save it, but at this point, you are declared "full retirement", and can no longer contribute, (or put back), money into your 401K.
Mostly, I expect people, (working people) that retire at age 55, fully expect to get back into the work force someday. Perhaps they were offered a nice "package" to retire, or were just tired of the "rat-race", so not many folks likely take this route.

401K plans are for "wage earners" only, so if you are retired, no wages, there is no way to re-start contributions.

That "age 55 retired" can not be changed again until age 59 1/2, when you will revert back to "regular" status.

I say again. It is one of the few things the gobment ever did that has no major drawbacks for a wage earner. Put in all you can as soon as you can.

The more you save, the more taxes you defer and the sooner that you retire. The most important thing for me is that the wife cannot get to it and spend it.