Do you know any part of the United States tax code by heart? No? I bet you do.
The term “401(k)” comes straight from the U.S. tax code and might just be the only part of the tax code that most Americans know.
Though, despite most of us having at least heard of 401(k)s, many Americans don’t know how they work. In fact, 33% of working Americans don’t even know if they have access to a 401(k) at all.
Don’t let that be you. Knowledge is power, and the more you know about the retirement and investment options available to you, the more you will be able to take control of your future.
Here are 13 facts you probably didn’t know about 401(k)s:
1. 401(k)s are tied to your job. You cannot open a 401(k) on your own, though you can contribute to a 401(k) once it has been opened, even if you have left the company.
2. There is no income limit to participate but there is a contribution limit. Your salary can be any amount. Your employment status doesn’t even have to be a salaried. You could be part time, hourly full-time, exempt or non-exempt. It doesn’t matter either way. What matters is that you have an employer that sets up the account and allows you to participate.
3. 59 ½ and 72 are two important numbers. The former is the age you must be before you can make withdrawals from your account without a tax penalty. The latter is the age when you have no choice but to make withdrawals.
4. Withdrawing the money before age 59 ½ is possible, but it will cost you. You’ll have to pay taxes on the money plus a hefty penalty. Try to avoid getting into the habit of thinking of the 401(k) as a bank account. Instead, think of it as the illiquid asset that it is. You’ll have more money in the end that way.
5. While you need to have a job with a participating plan to open a 401(k), you don’t have to stay at the job to continue putting money in it. As long as you opened the account with your employer, you can leave the account open with that employer for as long as you like, or at least for as long as the employer is in business. You can even continue making deposits into it, though your former employer will stop any matching.
6. A 401(k) is known as a defined contribution plan. That’s because the way you make contributions has specific designations that are defined by the IRS.
7. More than 80 million people in the United States participate in a 401(k).
8. A 401(k) is a great tool for helping you think long term about your retirement. Because there are so many benefits to keeping your money invested in the account, and so many penalties to removing it early, this type of account will help you focus on long term retirement savings without even trying.
9. Can’t afford to contribute? Do you feel that it’s impossible to take one more penny out of your paycheck to go in a 401(k) account? Think again. By not contributing to your 401(k) – even without a match – you’re forfeiting tax savings. If your employer offers a match, and you don’t take advantage of it, you’re essentially telling your employer to pay you less. Either way, you’re forfeiting some of your compensation.
10. More than ¾ of companies in the U.S. offer a match. Which means that for every percentage of income that you contribute, your company adds that much more money on top of your salary to go directly into your 401(k). With the average match in the U.S. being 4.7 percent, that money really adds up.
11. Your 401(k) makes a terrible emergency fund. It’s your money, and you can withdraw it from the account if you wish, but you’ll pay often steep penalties on top of taxes.
12. When the retirement plans we know today were developed, retirement simply didn’t last as long, because our lives didn’t last as long. Less money was needed because it was meant to support fewer years. Now that our life expectancies have increased, we have to rethink our retirement strategy. A 401(k) alone is a great component to an overall retirement strategy, but is generally not enough on its own.
13. 33% of employees don’t even know if they have access to a 401(k) or not. That means a full third of working Americans could be earning more for retirement with minimal effort, yet are not doing so.
Bottom Line
While everyone’s retirement plan will look different, one thing we know for sure is that a 401(k) is a great component to consider. There are risks, of course. There always are, with the stock market. But, at the very minimum, make sure you know which options are available to you for your retirement planning. To do otherwise is to risk leaving money on the table.