Traditional 401(k)
The traditional 401(k) is a popular retirement saving plan under the Defined Contribution Plan category.
They offer employees and employers flexibility in contributions, investment choices, and tax advantages.
Key Features
1) Contribution Limits: Employees can contribute a portion of their salary to a 401(k) plan, subject to annual contribution
limits set by the IRS. For 2024, the contribution limit is $23,000 for individuals under 50, with a combined
employee-employer contribution limit of $69,000.There is also a catch-up contribution of an additional $7,500 to
the total contribution for those 50 and older.
2) Employer Match: Many employers offer a matching contribution to employees’ 401(k) accounts, often up to
a certain percentage of the employee’s contributions. This matching contribution is an added incentive for
employees to save for retirement.
Tax Advantages
1)Pre-Tax Contributions:
Contributions to a traditional 401(k) are made with pre-tax dollars, reducing the employee’s taxable income in the current year.
2)Tax-Deferred Growth:
Investment earnings within the 401(k) plan grow tax-deferred until withdrawal during retirement, allowing for potential compounding growth over time.
3)Investment Options:
401(k) plans typically offer a range of investment options, including mutual funds, stocks, bonds, and target-date funds. Participants can choose how to allocate their contributions among these options based on their risk tolerance and investment goals.
4)Vesting:
Employees become vested in their 401(k) contributions, and any employer matches over time, meaning they gain ownership of these funds. Vesting schedules may vary by employer.
5)Portability:
If an employee changes jobs, they can often roll over their 401(k) account balance
into a new employer’s plan or an individual retirement account (IRA), maintaining the tax-advantaged
status of their retirement savings.
Considerations
1) Early Withdrawal Penalties: Withdrawals from a 401(k) before age 59½ may incur early withdrawal penalties and income taxes on the withdrawn amount.
2) Required Minimum Distributions (RMDs): Participants must start taking required minimum distributions (RMDs) from their 401(k) accounts beginning at age<br>
72 (or age 70½ for those who turned 70½ before January 1, 2020), subject to IRS rules.
3) Investment Risk: Participants bear the investment risk in a 401(k) plan, as account growth depends on the performance of the chosen investments
within the plan.
Benefits for Employees
- Opportunity for tax-deferred growth and potential for investment growth over time.
- Employer matching contributions can significantly boost retirement savings.
- Flexibility in investment choices and portability if changing jobs.
Benefits for Employers
⦁ Ability to offer a valuable employee benefit that promotes retirement savings.
⦁ Potential tax advantages for the employer, including deductible contributions and tax credits for specific plans.
⦁ Attract and retain top talent by offering a competitive retirement savings plan.
⦁ Conclusion:
⦁ Traditional 401(k) plans provide a structured and tax-advantaged approach to retirement savings, benefiting
employees and employers by fostering long-term financial security and retirement readiness. Understanding
the features and considerations of a traditional 401(k) plan is essential for making informed decisions about
retirement planning and investment strategies.