401(k) is a Defined Contribution (DC) plan and it allows you (an employee) to make pre-tax contributions to your own retirement account. Employers may make matching contributions up to a certain amount. 401(k) is a retirement savings account which offers tax advantages. It does not have the lifetime payout like pension plans. Due to the plans being invested with pre-tax contributions, withdrawing money before 59 ½ will be subject to early withdrawal penalties with some exceptions. And of course, all distributions will be taxes as ordinary income. This plan is called Defined Contribution because you know what you put in. But you will not know what you may get when you retire due to the market fluctuations.
Your employer serves as a “plan sponsor” and has another company administer the plan and its investment. This plan administrator is typically a mutual fund company, a brokerage firm, or an insurance company. You are responsible for the investment of your money by choosing investment options in the plan. Contribution limits are set every year to adjust to the high cost of living.
When you leave your employer, you may consider a 401k rollover, which lets you transfer money from a 401(k) you had at a previous job into an IRA or another eligible retirement plan within 60 days. A 401(k) rollover can save you money on taxes and is one of the best ways to move money between retirement accounts, if done correctly. No longer with an employer and want to know more about 401(k) rollover? Contact us for a free consultation.