The everything 401k podcast is now available! What is a 401k? Why should I have one? Who is responsible for managing a 401k account? How much can I contribute and what is a Roth 401k? These and many other questions are answered on this week’s episode of the Wiser Roundtable podcast.
“401ks are designed to get savers TO retirement. IRAs are designed to get account holders THROUGH retirement.” – Brad
What is a 401k? Why should I have one? Who is responsible for managing a 401k account? How much can I contribute and what is a Roth 401k? These and many other questions are answered on this week’s episode of the Wiser Roundtable podcast. Starting with the basics, a 401k comes from the tax code and allows employers to provide employees with a retirement savings program on a salary deferral basis. This gives the employee the option to defer a certain percentage of their salary into a retirement account. Employers may also contribute to this account, often referred to as “employer match” meaning they will contribute the same percentage that the employee contributes.
Who is responsible for managing these 401k accounts? The employer? The employee? The 401k is actually managed by a group of trustees. This group of trustees are fiduciaries to the participants, meaning they are responsible for ensuring all investment options are low cost, broadly diversified and take into account the participant’s specific situation. One of the most common questions that comes up in discussing 401ks is, “if my company goes out of business, will they take my 401k money?” and the answer is no. All money that goes into a 401k account is in trust. The money is held at a third-party custodian and is in the participant’s name. With that said, the employer does not have the ability to withdraw money from the account for their own gain. However, there have been instances of fraud stemming from the employer not depositing the “employee match” percentage the employer had agreed to. In situations like this, it is the trustee’s responsibility to review transactions, as well as monitor potential red flags and any instances of fraudulent activity.
As with nearly any financial account, there are rules to follow. The most basic rule for a 401k is the plan has a maximum dollar amount someone can put into it. Today, the maximum amount is $19,500 per year. If over the age of 50, a participant can contribute an additional $6,500 per year. It is important to keep in mind the idea of compounding interest. Although there is possibility to contribute more after turning 50, it is highly encouraged to start utilizing a 401k account as early as possible to reap the benefits gained from compound interest.
Some accounts may give the participant the option to contribute to a Roth 401k as opposed to the traditional 401k plan. The major difference between Roth 401k and traditional 401k relates to taxation. Money put into a Roth 401k are after-tax dollars, though, they will continue to grow tax-free. When taking funds out of a Roth 401k, they are deemed tax-free. Another difference between the two account types is the required minimum distribution. For a traditional 401k and based on the Secure Act, by age 72, a participant must withdraw a certain percentage of the account each year. However, the Roth 401k allows one to rollover the funds into a Roth IRA rather than requiring a withdrawal. It may be difficult to decide which account type is best, and with that, Casey suggests putting half into a traditional and the other half into a Roth 401k. By doing so, you are essentially filling two buckets both taxable and nontaxable, to allow for tax diversification and avoid future tax assumptions that may not be correct.
Investment options within a 401k plan are set up by the trustees. The “investment lineup” is created by the trustees that displays a variety of funds which allow participants to put money into periodically. There are two types of fund management: actively managed funds where there is a fund manager making the investment decisions, or passively managed funds meaning investing entirely into an index. Participants may choose to forgo the creation portfolio, in which case trustees will set a “target date fund” or “lifestyle fund,” where the fund manager will blend together different funds composed of equities, fixed income and others. This target date will have more risk for longer term funds and less risk for shorter term funds. Generally, the title for such funds will include the anticipated retirement year such as: Target Fund 2025. It falls on the shoulders of the trustees to identify the best funds at the lowest price point within the investment lineup, whereas the participant is in charge of finding the lowest fee possible for each investment. Today, it is common to find smaller companies offering low fees, just like the larger name companies.
The last thing to remember when it is time to withdraw money from a 401k account is that it should be planned very carefully. Why? Because oftentimes a distribution election is irrevocable. It is strongly encouraged to seek professional advice before making any decision regarding 401k withdrawals. Wiser Wealth is dedicated to giving our clients the best advice given their individual situation. Whether it be moving money into an IRA account or rolling over to a new employer’s 401k plan, all options should be thoroughly considered prior to taking action. Unfortunately, there is no equation or crystal ball to answer the question “have I saved enough?” though there are pre-planning decisions paired with professional consultations that can lead you down the road towards retirement, and ultimately financial freedom.
Wiser Wealth Management, Inc (“Wiser Wealth”) is a registered investment advisor with the U.S. Securities and Exchange Commission (SEC). As a registered investment advisor, Wiser Wealth and its employees are subject to various rules, filings, and requirements. You can visit the SEC’s website here to obtain further information on our firm or investment advisor’s registration.
Wiser Wealth’s website provides general information regarding our business along with access to additional investment related information, various financial calculators, and external / third party links. Material presented on this website is believed to be from reliable sources and is meant for informational purposes only. Wiser Wealth does not endorse or accept responsibility for the content of any third-party website and is not affiliated with any third-party website or social media page. Wiser Wealth does not expressly or implicitly adopt or endorse any of the expressions, opinions or content posted by third party websites or on social media pages. While Wiser Wealth uses reasonable efforts to obtain information from sources it believes to be reliable, we make no representation that the information or opinions contained in our publications are accurate, reliable, or complete.
To the extent that you utilize any financial calculators or links in our website, you acknowledge and understand that the information provided to you should not be construed as personal investment advice from Wiser Wealth or any of its investment professionals. Advice provided by Wiser Wealth is given only within the context of our contractual agreement with the client. Wiser Wealth does not offer legal, accounting or tax advice. Consult your own attorney, accountant, and other professionals for these services.
Sign up for our newsletter!
Our latest blogs, podcasts, and educational videos delivered to your inbox weekly.