Participating in a Workplace Retirement Plan
With traditional pension plans rapidly becoming phased out and Social Security's long-term future in doubt, more Americans shoulder the responsibility of funding their own retirement. Many workers rely increasingly on their workplace-sponsored retirement plans to provide the means to meet their investment goals. That's because these types of plans -- such as a 401(k), 403(b), or 457 plan -- offer a variety of attractive features that make investing for the future easy.
401(k), 403(b), and 457 plans allow you to contribute up to $19,500 of your salary in 2020. Keep in mind that individual plans may have lower limits on the amount you can contribute. In addition, individuals aged 50 and older who participate in these types of plans can take advantage of so-called "catch-up" contributions of an additional $6,500.
Traditional 401(k), 403(b) and 457 plans allow you to make contributions to the plan before taxes. Contributions are withdrawn from your salary, giving you the immediate advantage of lowering your taxable wages. For example, if your salary is $50,000 and you contribute $5,000 to your plan, your wages for federal income tax purposes are lowered to $45,000.
Any earnings on your contributions may grow on a tax-deferred basis, meaning that you don't pay taxes on the contributions and any earnings until they are withdrawn.1
401(k) plans come in two varieties: traditional and Roth-style plans. Your employer may choose to add a designated Roth 401(k) to your traditional 401(k) plan but may not offer only a Roth 401(k) without a traditional 401(k).
Under a Roth 401(k) plan, contributions are made in after-tax dollars, so there is no immediate tax benefit. However, any investment earnings on plan balances are tax-deferred and potentially tax free if all requirements are met (that is, they are qualified distributions).
Generally, qualified distributions from a Roth 401(k) must be made after five tax years from the first contribution AND after age 59½ or on account of death or disability. Nonqualified distributions are subject to income taxes and possibly an additional 10% penalty.
Generally, workplace retirement plans provide you with several options in which to invest your contributions. Such options may include stocks, bonds, and money market investments. This flexibility allows you to spread out your contributions, or diversify, among different types of investments, which may help reduce overall losses if an individual investment loses value.2
Borrowing From Your Retirement Plan
One potential advantage of many workplace retirement plans is that you may be able to borrow as much as 50% of your vested account balance, up to $50,000. In most cases, if you systematically pay back the loan with interest within five years, there are no penalties assessed to you. If you leave the company, however, you may have to pay back the loan in full immediately, depending on your plan's rules. In addition, loans not repaid to the plan within the stated time period are considered withdrawals and will be taxed and penalized accordingly.3
Make It Work for You
A workplace retirement plan can become a cornerstone of your personal retirement savings program. Consult with your plan administrator or financial professional to help you determine how your employer's plan could help you prepare for your financial future.
1Penalty-free "coronavirus-related" distributions (CRDs) may be available in 2020 under the CARES Act.
2Diversification does not ensure a profit or protect against loss in a declining market.
3Distributions made prior to age 59½ may be subject to an additional 10% federal tax. Higher loan limits and delayed repayment terms may apply for certain loans in 2020 under the CARES Act.