Any employer, except government entities, can offer a 401(k) plan. Here are the basics of 401(k) plans, although plan rules may vary:
Each employee participating in the plan determines how much money is to be automatically contributed from each paycheck. Generally, participants can invest an annual maximum of $22,500 in 2023, or $30,000 for those 50 or older.
Traditional contributions are made before taxes are deducted, which means that income taxes are not paid at the time of investment. Instead, taxes on both contributions and earnings are paid when the money is withdrawn.
Plans may allow Roth contributions, which are made with money that has been taxed. Money that’s been taxed won’t be taxed again. Additionally, earnings are tax- and penalty-free for qualified distributions.*
* Withdrawals from Roth accounts are tax- and penalty-free if the account was established at least five years before, and if the participant is at least 59½ years old, disabled or deceased. For nonqualified distributions, earnings are taxable and may be subject to a 10% early withdrawal penalty.
As an added incentive for their employees to invest, some employers make “matching” contributions to participant accounts. Some employers match employee contributions dollar for dollar, while others contribute a percentage of what employees contribute. Employers may also make discretionary contributions into participant accounts.
Participants always own 100% of their salary-deferral contributions. With employer contributions, participants often become vested over time.
Distributions from 401(k) plans are generally allowed at age 59½, or if the employee becomes disabled or leaves the employer sponsoring the plan (penalties may apply for early cash-out distributions). However, plans may allow ways to access 401(k) money early.
There are a number of options an employee can take when leaving the job:
To learn more about your options, contact your financial professional.
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The investments available in the plan — the most common options are mutual funds — are determined by the employer, who may get help from the plan's financial professional or a third-party fiduciary. Participants can decide which of the options to use.
Select a target date fund that is based on your nearest anticipated retirement date. A single investment provides a fund-of-funds portfolio of actively managed American Funds aligned with an investor’s time horizon.
Investors can build an investment portfolio of mutual funds (excluding tax-exempt funds) to meet their specific preferences and needs.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Although the target date portfolios are managed for investors on a projected retirement date time frame, the allocation strategy does not guarantee that investors' retirement goals will be met. Investment professionals manage the portfolio, moving it from a more growth-oriented strategy to a more income-oriented focus as the target date gets closer. The target date is the year that corresponds roughly to the year in which an investor is assumed to retire and begin taking withdrawals. Investment professionals continue to manage each portfolio for approximately 30 years after it reaches its target date.
This material does not constitute legal or tax advice. Investors should consult with their legal or tax advisors.
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