You probably already know that participating in an employer 401K plan is a good way to put aside money for your retirement, especially if your employer provides a 401K matching program. But there are some things to keep in mind when planning your 401K contributions, like the annual limits for investments, for example.
If you’re not all that familiar with how a 401K works, let’s review some of the basics. Then we’ll get to our four tips that can help you take full advantage of the benefits of saving for retirement with a 401K plan.
What Is a 401K plan?
A 401K is a retirement savings plan that is sponsored by your employer. It allows for pre- and post-tax dollars to be removed directly from your paycheck and deposited into your selection of investment accounts made available through your employer. These accounts are typically managed through a third-party investment firm, such as Vanguard or Fidelity to name just two.
Your employer is also able to contribute to these accounts through a 401K match.
What Is a 401K match?
Many employers offer what is referred to as matching funds to encourage their employees to save for retirement. These employers will offer up to a certain percentage of your salary as a match.
Say, for example, you are putting 10% of your paycheck into your 401K and your employer offers matching funds up to 3%. That means you’ll receive the full 3% of your salary from your employer as an investment into your 401K. However, if you are only contributing 2% of your salary, your employer will match only that 2%. That’s why it’s important to know what your employer’s matching amount is so you can take full advantage of these additional retirement funds.
How Much Can I Put into My 401K in 2017?
You can invest up to $18,000 in your 401K this year, plus an additional “catch-up” contribution of $6,000 if you are age 50 or older. If you wish to invest more than this amount, you’ll have to consider post-tax options such as an IRA, mutual funds, CDs or other investment vehicles. The IRS has complete details on retirement contribution limitations.
How Much Can I Put into My 401K Overall?
There is no lifetime limit on how much you can invest in your 401K, though obviously, the total amount is limited based on the annual restrictions and how long you remain employed.
Here’s how to get the most out of your 401K.
Put aside some money every single pay period for your retirement, whatever you can manage, even if it’s just 2% or 3% of your pre-tax salary. Over the years, it will certainly add up.
If your employer matches all or a portion of your contribution, that’s even better. In general, many employers offering a 401K plan also provide matching contributions. Some will do a full match of your contributions up to a certain dollar amount, and others will match a portion of what you’re putting in. For example, instead of just 3% of each paycheck going into your 401K, your employer could double that amount with a full match.
It’s a good idea to review your 401K plan with your employer and do the math when deciding how much to contribute to your plan. Otherwise you may be leaving free money on the table and not maximize your 401K.
2. Benefit From the Tax Advantages
Contributions to a 401K plan use pre-tax dollars. So funding your retirement this way can help to lower your taxable income and reduce your tax bill. And depending on your income, you may be eligible for a retirement savings contributions credit by participating in a 401K plan.
3. Keep Your Hands Off the Money
Borrowing or withdrawing money from a 401K plan before you reach retirement age can carry stiff penalties except in very specific circumstances. Not only will you have to pay taxes on the amount you withdraw but also a 10% early withdrawal penalty. If you’re desperate for money, consider other alternatives like credit cards, personal loans or borrowing from friends or family to find the funding you need. Keep your 401K dollars tucked away for retirement, and you’ll be able to watch it grow and accumulate over the years.
We get it though: Sometimes an emergency is an emergency and pulling money out of your retirement fund can seem like your only recourse. If that’s the situation you’re in, we’ve got a full explainer on how to withdraw money from your 401K — plus some alternatives you may not have thought of.
4. Pay Down Debt & Plan for Retirement
If you are trying to pay off a mountain of debt, it is tempting to put all your extra money toward paying down student loans, credit cards and other debts, and to neglect your retirement plans. By all means, you should focus on paying down high-interest debt, but at the very least try to contribute enough in your employer’s 401K plan to receive an employer’s free and matching contribution. And when your debt levels lower, you can contribute more and more to your retirement plan.
You can see how your debt is affecting your credit by checking your two free credit scores, updated every 14 days, on Credit.com. And you can find strategies for paying it down over in our Managing Debt learning center.
Got a question about saving for retirement? Feel free to ask away in the comments section and one of our experts will try to help!
This article has been updated. It was first published January 04, 2017.