401(k)s are one of the most important retirement accounts you can have—you can get a jumpstart on your savings with the help of an employer program. But if we’re honest, they can be difficult to fully understand. It can be hard to know if your 401(k) is working for you and your retirement goals. 

In this blog, we’ll cover some common questions about your 401(k) and the hidden benefits you can take advantage of now and in retirement. Use this blog to ask questions about your 401(k) and talk about it with your financial advisor. 

What is a traditional 401(k) and How Does It Work?

A traditional 401(k) is a retirement savings plan provided and sponsored by your employer. Unlike other individual retirement accounts, it allows you to invest pre-tax, directly from your  paycheck. Here’s how it works:

• Contributions: You choose a percentage of your salary to contribute to your 401(k) pre-tax. 
• Employer match: Many employers offer a matching contribution up to a certain percentage. For example, if you contribute 5% of your paycheck to the account, your employer may match up to 3%. 
• Investment options: Your 401(k) is typically invested in a variety of investment vehicles like stocks, bonds, mutual funds, and other securities. It is typically up to you to decide how to allocate your contributions. 
• Tax advantages: Your contributions and investment gains are tax-deferred until you withdraw the money. We’ll talk more about 401(k) taxes later in this blog. 
• Withdrawals: You can generally start withdrawing from your 401(k) without penalty at age 59 ½. If you withdraw before this age, you may face a 10% early withdrawal penalty in addition to ordinary income tax. Required Minimum Distributions (RMDs), which are IRS imposed  withdrawals from your 401(k), typically must begin by age 73 or 75 depending on your birth year.
• Loan and hardship withdrawals: Some 401(k) plans allow loans or hardship withdrawals, but these come with specific rules. We’ll cover more on loans later. 
• Contribution limits: The IRS has contribution limits for 401(k) plans that adjust every year. For 2024, the limit is $23,000 for employees under 50 and an additional $7,500 catchup contributions for those 50 and older. 

These are just the basics of 401(k) plans. Next, we’ll cover some more specific questions about your 401(k). 

How Much and How Often Can I Contribute? 

The IRS sets limits each year on how much you can contribute to a 401(k). As of 2024, here are the contribution limits: 

• Employee contributions: You can contribute up to $23,000 annually if you are under 50 years old. If you are 50 or older, you can make additional “catch-up” contributions. The limit for 2024 is $7,500, allowing you to contribute $30,500 annually. 
• Employer contributions: The combined total of employee and employer contributions cannot exceed $66,000 or 100% of your annual salary—whichever is less. 

The IRS doesn’t have limits on the frequency of your contributions. Your employer will deduct your set amount from your payroll automatically. Depending on your employer, you can adjust your contribution amount at any time, but your plan might restrict how often you can make changes. 

What are the Rules For Withdrawing or Taking a Loan from My 401(k)?

There are a few rules for withdrawing from your 401(k): 

• Age restrictions: You can begin withdrawing from your 401(k) without penalty at age 59 ½. At that point, withdrawals are only subject to ordinary income tax. After that, you must take your first RMDs by April 1st following the year you turn 73 if you were born between 1951 and 1958. By April 1st following the year you turn 75, if you were born in 1960 or later.  The exact amount of your RMD is determined by IRS life expectancy tables and your account balance.
• Early withdrawals: Withdrawals before 59 ½ are subject to a 10% early withdrawal penalty in addition to regular income tax. However, if you turn 55 or older during the calendar year you leave your job, you can begin taking 401k distributions without paying the early withdrawal penalty. Taxes will still apply.

The exception for early withdrawal penalties is if you withdraw as a result of financial hardship. Hardship withdrawals are allowed under specific circumstances like: 

• Unreimbursed medical expenses 
• Purchase of a new home 
• Tuition or educational fees 
• Prevention of eviction or foreclosure 
• Funeral expenses 
• Certain home repair expenses

You may also take out a loan from your 401(k) if the plan allows. This also comes with certain parameters: 

• Loan amount: You can borrow up to 50% of your account balance or $50,000, whichever is less. If you have an existing 401(k) loan, the amount of your new loan might be reduced. 
• Repayment terms: Loans have to be repaid within five years unless used for purchasing a primary residence like a home, which can have a longer repayment period. Repayments are made through payroll deductions. 
• Interest rates: Loans accrue interest, usually at a rate slightly above the prime rate. The interest paid goes back into your account. 
• Consequences of non-repayment: If you fail to repay your loan on schedule, it will be treated as a distribution, meaning it will be taxed and will be subject to a 10% early withdrawal penalty if you are under age 59 ½.. 
• Leaving your job: In most cases, if you leave your job with an outstanding loan, you’ll have to repay the full balance by the due date of your tax return for that year. If not, the loan will also be considered a distribution. 

How Do Pre-Tax and After-Tax Contributions Work? 

Traditional 401(k) contributions are pre-tax. They are deducted from your paycheck before income taxes. Another example of a pre-tax account is a traditional IRA. Pre-tax contributions have some benefits, including: 

• Tax reduction: Your contributions reduce your taxable income for the year. 
• Tax-deferred growth: Earnings on pre-tax contributions grow tax-deferred. This means you won’t pay taxes on investment gains, dividends, or interest until you withdraw the money. 
• Taxation on withdrawal: Withdrawals are taxed as ordinary income. We’ll talk more about how withdrawals are taxed later in this blog. 

After-tax contributions apply to Roth 401(k)s and Roth IRAs. They are slightly different than traditional 401(k)s and IRAs: 

• No immediate tax benefit. Contributions do not reduce your taxable income—you pay income tax on the money before it goes into your retirement account. 
• Tax-free growth. Like pre-tax contributions, after-tax contributions grow tax-deferred
• Tax-free withdrawals. Because  you already paid income tax on your contributions, all withdrawals from a Roth account are tax-free—even the gains—provided you are 59 ½ or older and the account has been open for at least five years. 

What are the Different Types of 401(k) Plans?

Employers have a few choices of 401(k) plans to provide their employees. Here is a rundown of each: 

1. Traditional 401(k) Plan

Traditional 401(k) plans are the pre-tax, tax-deferred plans. They are ideal for private sector businesses that want a flexible retirement savings option with immediate tax benefits. 

2. Roth 401(k) Plan

Roth 401(k) plans are the after-tax plans that feature tax-free withdrawals in retirement. These are most beneficial for employees who expect to be in a higher tax bracket during retirement and prefer to pay taxes on their contributions now. 

3. Safe Harbor 401(k) Plan

The key difference in a Safe Harbor 401(k) is that employer contributions are immediately vested—meaning employees own the contributions right away. Employers are required to make contributions that are either matching or non-elective. These plans also automatically meet non-discrimination testing.

4. SIMPLE 401(k) Plan

SIMPLE 401(k) plans are available to small businesses with 100 or fewer employees that want a straightforward, low-cost retirement plan option. They are usually easy to set up and employers must match employee contributions up to 3% of their salary or provide a non-elective contribution of 2% of their salary. 

5. Solo 401(k) Plan (One-Participant 401(k))

Solo 401(k) plans are ideal for self-employed individuals. Solo 401(k)s have high contribution limits and can be adjusted based on cash flow.

What Do I Do After I Max Out My 401(k)? 

If you’ve already maxed out your annual 401(k) contributions, that’s great! That means you’ve done all you can with your 401(k) for the year. Now, you have the opportunity to invest and save in other areas. Let’s take a look at your options. 

1. Contribute to an IRA (Individual Retirement Account)

Consider setting up an IRA to continue to contribute into retirement savings. You have the choice of either a traditional or Roth IRA, similar to your 401(k) options. Like your 401(k) options, traditional IRAs are tax-deferred and Roth IRAs are after-tax contributions with tax-free qualified withdrawals. 

2. Invest in a Taxable Investment Account

Taxable Investment accounts have no contribution limits. They also can act as a savings account rather than a retirement account—you can withdraw funds at any age without penalty. Like retirement accounts, you can invest in a wide range of assets. However, keep in mind that interest, capital gains, and dividends from these accounts are subject to taxes. 

3. Health Savings Account (HSA)

HSAs can act as extra money in your pocket for medical expenses. Contributions are tax deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free. If you’re close to retirement, consider an HSA to help cover medical expenses after you retire. After age 65, withdrawals for non-medical expenses are penalty free but taxed like a traditional IRA.

4. Increase Emergency Savings

After you’ve maxed out your 401(k), consider saving up more liquid assets that are easily accessible. This is a good time to make sure you have 3-6 months of living expenses saved in a high-yield savings account. 

5. Pay Down High-Interest Debt

Consider paying down high-interest debt after you’ve maxed out your 401(k). Paying down credit card or other loan debt can make your dollars go even further—you’ll avoid paying more interest over time. 

Should I Rebalance My 401(k)?

Rebalancing your 401(k) is a good practice to implement during your working years. Consider working with your financial advisor to help you rebalance your portfolio on a regular basis. Here are just a few benefits of rebalancing your 401(k): 

• Asset allocation. Over time, the performance of your investments can cause your portfolio to drift from its original allocation. Rebalancing your portfolio can bring your investments back into alignment. 
• Risk management. Keeping your portfolio balanced helps manage risk aligned with your risk tolerance and time horizon. Also, your risk tolerance might change as you age, so rebalancing your portfolio can help reflect your changing tolerance for risk. 
• Discipline and strategy. Rebalancing promotes a disciplined investment strategy by selling high and buying low. 

Many financial advisors will recommend you rebalance your portfolio annually when your asset allocation deviates by a certain percentage, or when life events or goals change. 

Who is Eligible to Be A 401(k) Beneficiary?

A beneficiary is someone you designate to receive the balance of your 401(k) account upon your death. Most often, individuals designate their spouse as a beneficiary, but you have other, options, including: 

• Children. Children over the age of 18 can be beneficiaries without the need for a trust or custodian.
• Relatives or friends. If you are married, designating relatives or friends as beneficiaries will require written spousal consent. 
• Entities. You can name trusts or charities as beneficiaries of your 401(k). Your 401(k) can also be made payable to your estate.
• Contingent beneficiaries. Consider naming contingent beneficiaries who will inherit the funds if your primary beneficiary passes away before you or cannot be located. 

Can You Have Multiple 401(k) Accounts? 

Yes, it’s possible to have more than one 401(k) account. You may have multiple 401(k) accounts if you change jobs and don’t roll over your old 401(k), if you have multiple employers, or if you are self-employed or have a side business. 

Can I Use My 401k to Start a Business? 

Yes! This is called a Rollover as Business Startup (ROBS). ROBS is a special arrangement that allows you to use money from your 401(k) or other eligible retirement accounts to invest in a new business or purchase an existing one without incurring early withdrawal penalties or taxes. If you’re interested in starting a business, there are some advantages of using ROBS: 

• No early withdrawal penalties or taxes: By using ROBS, you avoid the early withdrawal penalties and taxes that typically apply to withdrawing from your 401(k) before retirement age.
• Access to capital: You can access a large amount of capital to fund your business—sometimes more than you could obtain through loans. 
• Retain Ownership: ROBS allows you to retain full ownership and control of your business without taking on debt. 

Keep in mind, however, that maintaining a ROBS arrangement involves complex legal and regulatory requirements. Starting a business always comes with some level of risk—if your business fails, you could lose a significant portion of your retirement savings. 

There are also ongoing fees and costs associated with ROBS, so make sure you understand the financial commitment before agreeing to one—any amount you withdraw will affect your retirement savings! 

Can I Put My 401k in a Trust? 

As we mentioned before, you can name a trust as the beneficiary of your 401(k) account. However, you cannot directly transfer a 401(k) into a trust during your lifetime while still retaining the tax-deferred status of the account. 

Have More Questions About Your 401(k)?

401(k)s have a lot of potential for supporting your retirement goals. With added incentives like employer match and the option for tax-deferred contributions, small monthly contributions can go a long way. 

But we also understand that it’s difficult to know whether your 401(k) is working for you. At True Blue, we’ve worked with many employees and their 401(k) plans and have a thorough understanding of different employers and their retirement plans. We’d be happy to look at your 401(k) account with you. Contact us today for a free consultation! 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision. This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice.