401(k) FAQs: Understanding the Basics

Casual meeting between older married couple and their financial advisor

401(k) FAQs: Understanding the Basics

Most employees begin their retirement savings early into their careers. However, 401(k) plans, terminology, and processes can be incredibly confusing and difficult to understand. Here are some 401(k) FAQs to help employees and employers better understand the basics.

 

What is a 401(k)?

A 401(k) is a company-sponsored retirement savings plan reserved for pre-tax dollars contributed by employee and/or employer.

 

What is a deferral?

A deferral refers to the funds deducted from a paycheck and deposited into a 401(k) plan.

 

How much can an employee contribute each year?

The amount an employee is able to contribute each year depends on IRS retirement contribution plan limits each year. For 2020, the employee contribution limit is $19,500 per year.

 

How much do employees typically contribute to their 401(k)?

Many financial advisors suggest 15% of an employee’s income to be contributed to his or her 401(k) plan. Financial advisors also recommend that the older an employee begins saving for retirement, the higher the contribution amount should be to catch up.

 

Recent studies show that contribution levels vary across generations. For example, younger generations are more focused on student loan payments, raising a family, and saving to purchase a home, whereas older workers are contributing at higher levels as they near retirement.

 

Does the employer contribute to the 401(k)?

While employers are not required to contribute to employee 401(k) plans, it is highly encouraged as it provides higher employee morale and retention, as well as incentivizes employees to save for retirement. For 2020, employer contributions are limited to $59,000 per year.

 

What are the benefits of a 401(k) for employees?

Since 401(k) funds are pre-tax income dollars, contributions lower overall tax burdens and not subject to payroll and FICA taxes.

 

What are the benefits of a 401(k) for employers?

Like employees, employers may find savings in payroll and FICA taxes. Other benefits for employers include saving at least 7.65% on funds an employee contributes to his or her 401(k) plan, deductible business expense for any money contributed to an employee’s 401(k) plan, and for businesses looking to implement a 401(k) plan can receive a startup tax credit that alleviates administrative and startup costs.

 

When can an employee withdraw funds? Are there penalties?

While it is not advised to withdraw funds before retirement, sometimes life throws unexpected events that require withdrawal. Once an individual reaches the age of 59.5, they may begin withdrawing from a 401(k) plan without penalty. If money is withdrawn before 59.5 years of age, a 10% penalty is typically distributed, as well as any taxes on the distributed funds. There are some exceptions where a penalty can be waived, such as purchasing a first home or a medical hardship. All money withdrawn within the appropriate timeline is taxed at the applicable rate as income.

 

However, if money is not withdrawn by the age of 70.5, the IRS implements Required Minimum Distributions, which is money from your fund distributed to you based on age and life expectancy.

 

What happens to a 401(k) when an employee leaves or loses employment?

Most 401(k) plans are with a third-party provider, so employees are typically able to maintain the account until retirement. Employees are able to move their 401(k) plan to their new employer’s plan or transition to a personal retirement plan (also known as an “individual retirement account” or “IRA”). Another option would be to cash out the account.

 

Whether you’re looking for 401(k) plans or exploring new retirement saving options for your employees, Human Capital can assist you. We are partnered with a 401(k) provider with plans designed to align with business requirements at a competitive price, reduced cost per person,  and flexibility in plan features, such as eligibility criteria, matching contribution formulas, profit sharing, and safe harbor options. Contact Human Capital today to speak with an employee benefits specialist.

 

 

Source: Zenefits