Many people rely on their 401K plans for their retirement needs, and if that is the case, they should learn everything they can regarding these accounts. We have come across three things that many don’t realize about 401K retirement accounts:
1. Annual Limits
The IRS limits pre-tax deductions to an amount that changes annually. A person’s maximum before-tax contribution for 2011 is $16,500, which is unchanged from 2010. It is important to understand this limit. This figure indicates only the maximum amount that the employee can contribute from their pre-tax earnings to all of their 401(k) accounts. It does not include any matching funds that the employer may contribute.
And speaking of employer matching contributions, they are usually not vested, meaning they do not become the property of the employee, until a number of years have passed. The rules say that employer matching contributions must vest according to one of two schedules, either a 3-year “cliff” plan in which the employee becomes 100% vested after 3 years, or a 6-year “graded” plan, in which the employee gradually becomes vested at a rate of 20% per year in years 2 through 6.
3. IRAs and More
You can have more than one retirement account, but the specifics vary according to the type of accounts you wish to use. For instance, you can have a 401(k) account with a Roth IRA. But if you have a 401(k) with an employer match, don’t contribute to a Roth IRA until you have reached your employer’s match limit. Once you reach your employer’s match limit, you may contribute additional retirement savings in a Roth IRA, otherwise, you are, in essence, giving up free money by not fully using the employer match.
Retirement planning also needs to mesh with your estate planning. In fact, just naming your beneficiary on your 401K account is an aspect of estate planning that you should review and discuss with your estate planning attorney.