Your 401(k) is a great vehicle to use to plan and invest for retirement. There are 5 facts about your 401(k) that you need to know to invest like a DIY millionaire. These 5 items can help you make sure you manage your 401(k) in the most productive and profitable manner. Get to know these 5 details as thoroughly as you can.
- Annual contribution limits. The Internal Revenue Service (IRS) sets legal limits on how much you, as the employee, can contribute to your 401(k) each year. In 2017, you can contribute up to $18,000. You can divide this money between a traditional and a Roth 401(k). This limit does not apply to your employer match, if offered one. If you max out your 401(k) each year, and your employer matches, you will have more than $18,000 in your 401(k). That is completely legitimate according to the IRS
- Vesting schedules. You are always entitled to your employee contributions and its earnings. However, if your employer provides a match, you are not entitled to the employer contributions and its earnings until you are “vested.” Each employer determines its own vesting schedule. Some are immediate (i.e. you are vested after your hire date), while others are incremental (i.e. you get 25% of your match after year 1 and so forth) or some are cliff (i.e. you get 100% but only after two years of service).
- Qualified distributions. Your 401(k) is meant to be a long-term investment account. You may begin, but are not required to, take out qualified distributions at age fifty-nine and half. You will pay any applicable ordinary income taxes on the withdrawal, if it is a traditional, and similarly on any employer match money from the Roth.
- Early withdrawal penalties. Your plan may allow you to take out partial or hardship withdrawals. However early withdrawals from the traditional and Roth may be subject to a 10 percent tax penalty, in additional to any applicable ordinary income taxes.
- Pre-selected investment options. Your employer will select the investments in your 401(k). Most plans offer three options, while the average plan includes at least eight to twelve investment options. The most common type of investment is a mutual fund. Unlike an individual retirement account (IRA), where you can select from a wide variety of investment products, you will be limited to this preselected menu of options.
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