401(k) Plans Frequently Asked Questions

Saving in a 401(k) plan is one of the most popular ways to work towards your retirement goals. If you’re new to these plans, you may have questions about what they are and how to use them.

Put simply, a 401(k) plan is an employer-sponsored savings plan that allows you to contribute a portion of your salary to your 401(k) plan account for retirement. It may also offer certain tax advantages.

While the particulars of each 401(k) plan may vary from company to company, there are some 401(k) plan basics you should know. Let’s talk through some of common frequently asked questions surrounding these plans

How Does a 401(k) Work?

With a traditional 401(k) plan, you may select a percentage of your salary that you would like to contribute to your 401(k) plan account each pay period, and that amount is contributed to your 401(k) plan account on a pre-tax basis —in effect lowering your taxable income.¹ Your 401(k) plan investments have the potential to grow on a tax-deferred basis, meaning you pay taxes on the money (both principal and earnings) you withdraw from the account in retirement.

Some companies also offer the ability to save through a Roth designated account in your 401(k) plan. With this type of plan account, you make contributions to such account on an after tax basis, but then your withdrawals from such account in retirement are generally federal income tax-free as long as they are qualified distributions and subject to satisfaction of certain relevant conditions.

You’ll need to decide how you want to invest the money you’re contributing to your 401(k) plan account. Workplace retirement 401(k) plans generally allow you to choose from a menu of investment options, such as mutual funds, exchange-traded funds (ETFs), and fixed income investments (e.g., bonds and bond funds). Some plan investment menus may also give you the option to invest in a single target date fund, which automatically adjusts its mix of securities and risk profile according to your approximate date of retirement.

If you’re not sure which investment strategy is right for you, it can be a good idea to talk to your employer, as plan sponsor and legal and tax advisors.

How Much Should I Contribute?

This is a personal decision, and it will largely be based on your financial needs and goals. A retirement calculator or financial professional can give you a sense of what might be a sound target for your unique situation, and from it you can determine a contribution percentage that can help you get there.

As a starting point, you may want to save enough to take advantage of any matching contributions offered by your employer under your plan. This so-called 401(k) plan match is money that your employer puts into your 401(k) plan account for every dollar you contribute, up to a specified cap, as a way to encourage you to utilize your workplace plan to save for retirement.² If you’re able, it can be a good idea to contribute enough to get the full match; otherwise you’re essentially leaving money on the table. 

How Do I Sign Up for the Plan?

As a new hire, during your company’s benefits enrollment period you may have an opportunity to enroll in the 401(k) plan and elect a percentage of your salary to contribute to it.

In some cases, you may need to meet certain requirements before you can enroll, like working at the company for a specified amount of time. And at some companies, they’ve designed the plan so that you don’t need to take any action on your own; you’ll be automatically enrolled in the plan.

Check with your benefits department about how it works at your organization.

Are There Limits on How Much I Can Contribute?

Yes, the IRS puts a cap on how much employees can contribute to a 401(k) plan each year. For 2024, you can contribute up to $23,000 into your 401(k) plan account.³ If you’re 50 or older, you can also make up to an additional $7,500 in catch-up contributions. This is a way to super-charge your savings efforts in the years leading up to retirement.

When Can I Take Money Out of My 401(k)?

Once you turn 59 ½, you can start taking distributions from your 401(k) plan account without incurring an early withdrawal penalty tax.⁴ With a traditional 401(k) plan, there’s also a date by which you must start withdrawing money from your account (and paying taxes on it at the time of distribution). These withdrawals are known as Required Minimum Distributions. The age at which an individual must start taking RMDs (“RMD Age”), depends on the individual’s date of birth. RMD Age is (a) age 70 ½ for individuals born before July 1, 1949, (b) age 72 for individuals born after June 30, 1949, but before 1951, (c) age 73 for individuals born after 1950, but before 1960, and (d) age 75 for all others – note, apparent drafting error in the statutory language in the SECURE 2.0 Act of 2022, which was signed into law on December 29, 2022, makes it unclear when age 75 starts to apply in lieu of age 73, but it appears age 75 is intended to apply if born after 1959,

What If I Want to Withdraw from My 401(k) Plan Before Attaining Age 59 ½ or RMD Age?

If you make a withdrawal before age 59½, you might have to pay a 10% tax penalty, unless you qualify for an exception.⁵ Hardship withdrawals are sometimes allowed for people who demonstrate financial need, but restrictions may apply.

If you need cash and have exhausted other options, you may be able to borrow from your 401(k) plan without a penalty as long as you pay back the loan as outlined in the agreement, provided you 401(k) plan permits such participant loans.⁶ But be aware, you may have to pay the loan back quickly if you leave or lose your job, or else face a penalty.

While participant loans from their 401(k) plan may be justified in some cases, you may want to think carefully and consult your tax and legal advisors before turning to this option. Even if you replace the funds you borrow, while that money is out of the plan it’s not benefitting from the effects of compounding—in other words, earning interest on the principal balance and the accumulated interest and investment gains—which gives your money the potential to grow exponentially over time. Moreover, many people stop contributing to their 401(k) plan while they have a loan outstanding. Taken together, these actions may derail your savings efforts.

What Happens to the Money in My 401(k) Plan Account if I Leave My Job?

Your 401(k) plan’s vested balance—that is, the money you’ve contributed, any employer match whose vesting conditions you’ve satisfied, and the earnings on both—is yours to keep.

The amount of your employer’s matching contributions that is considered vested depends on the plan’s vesting schedule. In some cases, the employer matching contribution is vested right away. In other plans, the vested timeframe might increase with your tenure at the company.⁷

What If I Have 401(k)s from Previous Employers?

You might be able to keep the 401(k) plan where it is, or transfer the funds to your new employer’s 401(k) plan, where permitted, if you like the convenience of having just one account to keep track of. Another option is to roll the assets held in your 401(k) account into an IRA.⁸ There is no right or wrong answer—only what works best for you based on your individual facts and circumstances. Consider consulting with a legal and tax advisor.

The Bottom Line

The most crucial move you can make with a 401(k) plan savings vehicle is to get started. Thanks to the power of compounding, the longer your money is invested, the longer your contributions to the plan, as well any interest and earnings, have time to potentially grow in line with the markets.

If you have questions about your 401(k) plan, reach out to your employer as the plan sponsor of your plan. If you need help with your investment strategy or in determining how your 401(k) plan can work alongside other savings and investments vehicles to help you meet your retirement goals, you may want to speak to a financial professional who can provide guidance tailored to your situation.

Footnotes:

¹ IRS.gov, "401(k) Plan Overview." Available at https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview. Accessed March 26, 2024.

² Investor.gov, "Introduction Investing Basics Glossary: 401(k) Plan." Available at https://www.investor.gov/introduction-investing/investing-basics/glossary/401k-plan.  Accessed March 26, 2024.

³ IRS.gov  "Retirement Topics - 401(k) and Profit Sharing Plan Contribution Limits" Available at https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits. Accessed March 26, 2024.

⁴ Retirement Topics - Exceptions to Tax on Early Distributions. Available at https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions#:~:text=Generally%2C%20the%20amounts%20an%20individual,tax%20unless%20an%20exception%20applies. Accessed March 26, 2024.

⁵ Retirement Topics - Exceptions to Tax on Early Distributions. Available at https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions#:~:text=Generally%2C%20the%20amounts%20an%20individual,tax%20unless%20an%20exception%20applies. Accessed March 26, 2024.

⁶ Consider a Loan From Your 401 (k) Plan. Available at https://www.irs.gov/retirement-plans/considering-a-loan-from-your-401k-plan-2. Accessed March 26, 2024.

⁷ Retirement Topics - Vesting. Available at https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-vesting. Accessed March 26, 2024.

⁸ FINRA Reminds Firms of Their Responsibilities Concerning IRA Rollovers Available at https://www.finra.org/rules-guidance/notices/13-45 Accessed March 26, 2024.