All About 401(k)s

If you plan to retire someday, a 401(k) plan may be on your radar. 401(k)s can help you save retirement money to help you enjoy your golden years financially secure. In honor of National 401(k) Day on September 10th, here are some facts about the 401(k):

The History of the 401(k)

In the Revenue Act of 1978, a “Section 401(k)”allowed employees to avoid paying taxes on deferred compensation. In 1980, a benefits consultant named Ted Benna was looking for a tax-friendly retirement program for one of his clients. 

He referred to Section 401k and decided it was a good idea for employees to contribute pre-tax money into a retirement plan while earning an employer match. Even though Benna’s client didn’t follow through with his idea, Benna incorporated the idea into his own company, The Johnson Companies. In 1981, the IRS started allowing employees to fund their 401(k)s through payroll deductions, and the rest is history. 

How a 401(k) Works

If your employer offers a 401(k) plan, you may choose to enroll as long as you meet the eligibility requirements. Before you contribute to a 401(k), you’ll need to determine whether you want a Traditional 401(k) or Roth 401(k) and decide how much you want to save. Here’s how each type of 401(k) works:

Traditional 401(k): Contributions are made with pre-tax dollars with a Traditional 401(k). Your contributions will help reduce your income tax by offsetting income. With pre-tax contributions, you won't pay taxes on the money you contribute or your investment's growth until you withdraw from your investment account. When you retire, the funds are taxed as regular income.

Roth 401(k): If you contribute to a Roth 401(k), your contributions are made with after-tax dollars. Your contributions will grow tax-free, and you won’t be responsible for paying taxes on the contributions or accumulation inside the account on withdraws during retirement. 

How to Contribute to a 401(k) 

You have the freedom to choose how much you contribute to your 401(k). Keep in mind, however, that the IRS sets maximum contributions every year. For 2021, the maximum is $19,500 if you’re under 50. If you’re 50 and over, you can contribute $6,500 more or a total of $26,000.

So how do you know how much to contribute? It all depends on how much you can afford, how much you want to save for retirement, and how much you may need in retirement. Your financial professional can help you determine all of these factors. Ideally, contribute enough to meet your employer match, so you don’t miss out on “free money.”

After you decide how much you want to contribute, set up a payroll deduction with your HR department or 401(k) custodian. Each time you get paid, a certain amount will be deducted and go directly into your 401(k) account. Your human resources department can guide you through this process. 

Consult Your Financial Professional

Your financial professional can help you determine a 401(k) plan for your unique lifestyle and retirement goals.

Important Disclosures:

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 investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

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