What is a 401(k) and how does it work?

A 401(k) plan is a common retirement savings plan available to people in the US. Usually, a 401(k) is offered by employers as an employee benefit. When you sign up for a 401(k) plan, you are agreeing to a portion of your paycheck being paid into your 401(k).

There are many benefits associated with 401(k) plans. First, the money you contribute to a 401(k) is pre-tax, meaning you do not have to pay taxes on the amount you set aside. Another great benefit is that many employers match your contributions up to a certain amount.

Once you and your employer make regular contributions to your 401(k), you can decide how you want that money to be invested. Whether you select a more aggressive investment plan or a more conservative one is up to you.

How do I use the 401(k) calculator?

The 401(k) calculator can help you determine how this particular account will help you prepare for retirement. By inputting your investment details such as your retirement age, current contribution percentage, annual income, and existing balance, you can get an idea of how much youโ€™ll have saved when you retire.

Since the money you set aside is then invested, there will always be a margin of error depending on your investment portfolio and how well the market performs. Regardless of how your portfolio performs, setting aside money in a 401(k) can help you feel confident as you enter retirement.

How much will my 401(k) pay me per month?

When you reach the age of 72, you will be subject to required minimum distributions (RMDs) which is a monthly amount that you must withdraw from your 401(k). The amount that you will receive from your 401(k) each month will depend on how much you put into it.

Even if you start withdrawing money on your own before RMDs set in, the monthly amount you withdraw will vary. Itโ€™s best to keep your monthly withdrawal amount as modest as possible so that your funds can last as long as you need them to. You can withdraw as much as you want but withdrawing roughly 4% of your balance each year is a good rule of thumb.

What is the difference between a 401(k) and a Roth IRA?

The main differences between a traditional 401(k) and a Roth IRA have to do with how the two accounts are taxed. Both of these terms refer to common retirement savings accounts, but with a traditional 401(k), you are taxed on the money you withdraw. Since you donโ€™t pay taxes on the money you put in, the amount you have to invest is higher and can lead to larger gains over the lifetime of your account.

With a Roth IRA, the money you add to the account is post-tax, meaning youโ€™ll pay taxes on it now. If you are fairly young, it is probably safe to assume that you are in a lower tax bracket now than you will be when you retire, so youโ€™ll pay less money in taxes this way.

Both have pros and cons, and many people choose to open both accounts so they can enjoy the benefits that come with each.

How does my 401(k) earn money?

The balance in your 401(k) will grow even if you stop adding money to it because it is a type of investment account. Your balance does not just sit there and wait for you to retire.

Instead, you choose how to invest your account balance and build on your account balance that way, too. Since you and your employer make monthly contributions, and your balance grows due to investments, 401(k)s have a TON of growth potential over time.

What are the yearly 401(k) contribution limits?

The Internal Revenue Service (IRS) sets contribution limits on a yearly basis and places that information online here. For 2022, most individuals can contribute up to $20,500. If you are 50 years old or older, you can take part in โ€œcatch-upโ€ contributions and put an additional $6,500 into your 401(k).

There are also limits to how much you and your employer can contribute together. If your employer offers employee matching, the combined contribution for 2022 cannot be more than $61,000 for most people. For those over 50 years of age, it cannot exceed $67,500.

How much of each paycheck should go to my 401(k)

Generally setting aside 15% of your income for retirement is a good benchmark. This 15% is a combination of all your retirement account contributions, as well as your employer match. If your employer will match up to 6% income for retirement, you should max out that benefit.

If you contribute 6% to your 401(k) and your employer matches your contribution, also putting in 6%, then youโ€™re almost to the total goal of 15%. By increasing your contribution by just a few percentage points, you can hit the target savings percentage.