Updated 10/21/22 with 2023 contribution limits
As always, I offer no credentials nor am I a financial advisor. I do offer to the reader my own research and opinions which should be checked with your accountant or tax advisor and your own investigation before taking any actions based on this post or the links it contains. Caveat emptor!
OVERVIEW
This thread is meant to be a summary of information about 401k plans and provide some beneficial and informative links to good sources for further information and maybe provide some "Hey, I didn't know that about 401k's!" insight. It is not meant to be comprehensive and, as always, you should check your plan documents and with your plan provider for specifics to your situation.
SOME 401K RULES
This is not comprehensive, but does list a handful of the important rules:
[These links are also now under Personal Finance in the secondary navigation menu near the top.]
As always, I offer no credentials nor am I a financial advisor. I do offer to the reader my own research and opinions which should be checked with your accountant or tax advisor and your own investigation before taking any actions based on this post or the links it contains. Caveat emptor!
OVERVIEW
This thread is meant to be a summary of information about 401k plans and provide some beneficial and informative links to good sources for further information and maybe provide some "Hey, I didn't know that about 401k's!" insight. It is not meant to be comprehensive and, as always, you should check your plan documents and with your plan provider for specifics to your situation.
SOME 401K RULES
This is not comprehensive, but does list a handful of the important rules:
- In 2023, your maximum individual contribution is $22,500 (or $30,000 if over 50 years old)
- IN 2023, the IRS also allows you & your employer to put a total of $66,000 (or $73,500 if over 50 years old). This means you can contribute, your employer can match your contribution, and your employer can contribute up to that limit.
- 401k limits are separate from other limits (457b, IRA, HSA, 403b, FSA, etc.)
- You are generally penalized if you withdraw funds before the age of 59.5. There are exceptions but you should consider your 401k investment to be to that age before you withdraw.
- You DO NOT have to withdraw or transfer funds out of your 401k if you change jobs. It may or may not be a good idea to transfer to your new employer's plan (or an IRA) but you should understand costs, options, etc. in BOTH plans before doing any transfers. Definitely DO NOT withdraw from the 401k just because you change employers. You will pay the IRS a 10% penalty if you do so!
- Immediate tax break (contributions come out of check before taxes are withheld).
- Simplified example: You are in the 20% tax bracket. You contribute $1000 per month to your 401k. Your taxes are reduced by $200. Thus saving $1000 only "costs" you $800.
- Employer Matching (i.e. you contribute 5% of your salary and employer matches first 3% plus 50% of the next 2% so the amount you have in the 401k is now 5% + 3% + .5% + .5% = 9%)
- Growth is tax deferred. This applies to dividends, capital gains, and other distributions. You don't pay taxes on these as you would in a taxable brokerage account.
- Simplified example: You are in the 22% tax bracket (which means you pay 15% on capital gains). You contribute $1000 per month to your 401k and $1000 per month into your brokerage account. Your dividend yield in each account is 5% for the year. You now have $1050 in your 401k and $1,050-(50*15%)=$1,042.50 in your taxable account.
- You can exchange funds and/or do buying/selling in a 401k account without having to pay capital gains taxes.
- Simplified example: Assume you bought 100 shares of a fund that cost $10 on January 2, 2020. That fund goes up to $12 at the end of the year and you decide you want to sell it in the 401k account and buy a different fund because you want to re-balance your asset allocation. You can sell the old fund and collect $1,200 in the 401k account and buy the new fund without having to pay capital gains on the $200 gain from the sell.
- HOWEVER, if you did this in your taxable brokerage account (and assuming you have to pay a 15% capital gains rate): You would end up with [$1,200-(200*15%)]=$1,170 in your taxable account.
- Multiply these numbers by 30 years of transactions and growth and gains and the numbers become staggering: Imagine you have a 10% average yearly growth/return in the same two accounts. You sell both in 2050 (and are still in a 15% capital gain rate: Your 401k now has about $10,000 and your taxable brokerage has [10,000-(9000*.15)]=$8,650
- You can usually contribute a lot more to a 401k than an IRA.
- Generally penalty-free withdrawals are not available. Withdrawing before age 59.5 usually results in a 10% penalty
- Fund availability and expenses may erode returns.
- Employer can change funds and provider at any time
- Not insured
- Vesting of employer contributions may require longer-term commitment to company
- When employment ends at one employer, you don't have to rollover funds to the new employer plan. You do have options: leave money where it is, move to new plan, move to an IRA (called a rollover), take a distribution (possibly with penalty)
- Required Minimum Distributions (RMDs) must be taken according to the appropriate IRS RMD table after age 70.5
- After-tax 401k contributions are available at some employers.
- Many plans do not provide indexing options that are low expense. Don't just accept this as something that is unchangeable.
- You should advocate for your company to provide low-cost indexing options and an appropriate plan that meets your needs!
- Solo 401K plans can be a great way to save more than the individual limit. Good for sole propritors, partnerships and some corporation structures.
- WhiteCoatInvestor's Overview of Rules for having Multiple 401k Plans
- IRS.gov Overview of 401k and profit-sharing plan limits
- Bogleheads.org wiki on 401k plans
- 401k Help Center
- What is a Solo 401k?
- Solo 401k Options
- After-tax 401k
- Types of available Employer Retirement Plans
- Roth 401(k), Roth IRA, and Pre-tax 401(k) Retirement Accounts
- Brightscope/ICI research on 401k plans
- 4Q Basket Case's overview of how 401k works
[These links are also now under Personal Finance in the secondary navigation menu near the top.]
Last edited: