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What is a 401(k)?

Jan 4, 2022
Empower Insights

Many employers offer this benefit to employees

There are many great ways to save money and protect your future, but one of the most popular options is to save in a 401(k) plan. Read on to learn more about 401(k) plans and how they work.

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What is a 401(k)?

A 401(k) plan is a defined contribution program established and offered by many employers in the private sector. It provides employees with the opportunity to save, invest and potentially grow money for retirement. Participating individuals can defer a specific percentage of their paychecks into their account. 

What is a 401(k) recordkeeper?

A recordkeeper is the service provider selected by your employer to help administer your 401(k) plan. 

Do I have to enroll?

In some cases, yes. With some employers, you may have to sign up on your own and enter all your information. 

However, many employers today make it super easy by “automatically enrolling” new workers in their 401(k) plans. In other words, once you’re hired, an account may be created for you at a default contribution rate, which is typically 3-4% of your salary as determined by your employer. Regardless of how you enroll, it’s always a good idea to log in and review your preferences, like your beneficiary designation and investment mix, to confirm everything is correct. 

How much should I contribute to my 401(k)?

It’s important to consider your lifestyle, budget, compensation and retirement goals before making an election. Empower insight shows people who set their contribution rate to 10% are on pace to replace more than 100% of their working income in retirement.1 But if you can’t afford to save that much right now, don’t worry — you can change your contribution rate when you’re able to save more. You can also check with your provider to see if you can sign up for automatic increases. Scheduling your contribution rate to increase by 1% every January is a simple way to help gain more ground.   

How much can I contribute?

Every year, the IRS establishes different limits on how much you can save for retirement. In 2022,  you can sock away a total of $20,500 in your 401(k) plan on your own (not counting any employer-matching dollars). If you’re age 50 or older, you can put away up to an additional $6,500 in catch-up contributions

What’s a company match?

It’s often referred to as “free money.” That’s because when you contribute to your 401(k) plan, your company may, too. Many employers will usually match 50% or 100% of your contributions up to a certain amount to help you grow your nest egg. For example, if your organization offered a full match of 5% and you set your deferral rate to 5% (or higher), you would essentially double your total investment when fully vested. 

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What are my investment options?

Your employer typically selects and puts together a diverse lineup of investments that is available within your 401(k) program, with all the available investment options overseen by professional money managers. This lineup may include target date funds, target risk funds, individual mutual funds or collective investment trusts and a managed accounts service among other options. 

Learning the basics of investing can help you build a strategy that fits both your current needs and your long-term goals. Remember, investing can sometimes be confusing and complex so don’t be afraid to ask for help. A financial advisor can have a big impact on how confident you feel about your prospects going forward.

What should I do with my 401(k) account when I leave my job?

In general, you can keep your money where it is, move it to a 401(k) plan with  your new employer or roll over your funds to an IRA. You could also choose to cash out your balance, but you may face an early distribution penalty depending on your age and situation in addition to income taxes. If you need help figuring out what to do with your 401(k) account when you leave a job, consider talking with a financial advisor, who can help evaluate your circumstances and explain your options.  

How do I take a withdrawal?

Generally speaking, you can start accessing the assets in your 401(k) account once you turn age 59½, usually in the form of periodic payments or as a lump sum. You don’t have to start tapping into it then, but the IRS mandates that you must begin making required minimum distributions in the year you turn age 72.

Be mindful if you’re thinking about touching your 401(k) funds before age 59½. In most instances, if your request doesn’t meet the conditions of a qualified distribution, it’ll be subject to a 10% early withdrawal fee as well as any potential income taxes. Those costs can add up fast, so you may want to think of your 401(k) account as a last resort. 

1 Empower Institute, “Scoring the Progress of Retirement Savers 2020,” September 2020.

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