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The Nuts and Bolts of a 401(k) plan


Contributions

Elective Contributions

Elective contributions are contributions that your employer makes to your 401(k) plan because you elect to make them. You choose to contribute part of your pay to the 401(k) plan. You are not taxed on any part of your pay that you contribute to the 401(k) plan.

SUGGESTION: While you are investing in a traditional 401(k) plan, you don't pay taxes on the pre-tax dollars you invest, and you don't pay taxes on the amount your investments earn. You don't pay any taxes on 401(k) money until you withdraw the money. If you wait until retirement, your tax bracket may be lower than it is now.

SUGGESTION: Take advantage of pre-tax contributions to your 401(k) plan. Consider contributing the maximum pre-tax amount allowable. If you are in the 25% tax bracket and contribute $19,000 to your 401(k) plan, you will pay $4,750 ($19,000 x 25%) less in taxes now on that contribution. You'll eventually pay tax on the money you withdraw, but you don't have to pay it now. Also, the earnings on your $19,000 will accumulate tax-deferred until you make withdrawals.

SUGGESTION: If your plan limits you from making the maximum annual pre-tax 401(k) contribution set by the IRS ($19,000 in 2019, $18,500 in 2018 )* and you are eligible to establish a Roth IRA, consider saving $6,000 in the Roth IRA in 2019 or $7,000 if you are at least age 50 ($6,500 in 2018) and put the maximum your plan allows in the 401(k) plan. Don't forget to take advantage of any employer matching contributions in your 401(k) plan first.

* plus $6,000 in 2019 (same in 2018) in catch-up contributions if you are at least age 50

Some employers are now offering an option called the Roth 401(k). Here, your elective contributions are made on an after-tax basis. However, when you withdraw the funds, all withdrawals will be tax-free once certain conditions have been satisfied. This is similar to the Roth IRA. In deciding whether to contribute to a Roth 401(k) or to a traditional 401(k), you would look at the same considerations outlined in the Introduction on whether or not to contribute to a Roth IRA. If you expect your tax bracket to be higher during retirement, the Roth 401(k) may make more sense than the traditional 401(k). However, if you expect your tax bracket during retirement to be lower than your current bracket, you may be better off to take advantage of the deductibility of contributions to a traditional 401(k).

The larger percentage of your pay you invest in your 401(k) and other retirement plans, the more money you'll have when you retire. Depending on your company, you may be able to save up to 100% of your pay in a 401(k) plan. If you are considered a "highly compensated employee," as defined by the IRS, the amount you can contribute may be limited.

SUGGESTION: Even if you will have a pension or savings from other accounts, you should still be saving in your 401(k) plan. You'll be on the way to building a financially independent retirement.

NOTE: The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 1/2 may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs.  Their tax treatment may change.

Voluntary After-tax Contributions

Some 401(k) plans allow you to contribute after-tax money to the plan in addition to your pre-tax contributions. Remember to consider other tax-free and tax-deferred ways to save before doing this.

Employer Matching Contributions

Many companies will match a part of what you save in the 401(k) plan by making a contribution to the plan for you. No matter when you leave the company, you can take all the money you've contributed and the earnings with you, and—depending on how long you've been with the company—you can take all or a part of the company's matching contributions, too. Employer matching contributions must vest at a rate at least as liberal as one of the following schedules:

  1. three-year cliff vesting, which is vesting after three years of service;
  2. six-year graduated vesting, where the employee is entitled to 20% of the employer matching contribution after two years, and 20% for each year thereafter until 100% vesting is reached after six years.



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Securities and advisory services are offered through Santander Investment Services, a division of Santander Securities LLC. Santander Securities LLC is a registered broker/dealer, Member FINRA and SIPC and a registered investment advisor. Insurance is offered through Santander Securities LLC or its affiliates.