Traditional 401(k)s in 2024: What You Should Know
Traditional 401(k)s in 2024: What You Should Know
Monday, February 26th, 2024
What’s A Traditional 401(k)?
A traditional 401(k) is an employer-sponsored retirement plan that has helped many invest for a comfortable, stress-free retirement.
The 401(k) was created in the late 1970s, and in recent years, the 401(k) has become one of the most popular retirement plans.
In fact, as of data gathered by September 30, 2023, 401(k) plans hold $6.9 trillion in assets, according to the Investment Company Institute.
When it comes to contributing to a 401(k), it’s done with pre-tax dollars, meaning contributions are automatically deducted from your paycheck.
Due to their immense popularity, and the fact that many employers offer 401(k)s, it’s worth understanding how a 401(k) works.
Traditional 401(k) Eligibility
In terms of eligibility, you must be allowed to participate in a 401(k) if you meet the following requirements:
- You’ve reached the age of 21
- Have at least 1 year of service (a traditional 401(k) may require 2 years of service; however, you must be allowed to make contributions after no more than 1 year of service)
Also, note that you may not be excluded from contributing to a 401(k) based on age.
Contribution Limits
Contribution limits are generally subject to cost-of-living adjustments. The contribution limits on employee elective deferrals are:
If you’re 50 or over at the end of the calendar year, you’re permitted “catch-up” contributions. Catch-up contributions are as follows:
This means it’s possible to contribute a combined $30,500 for 2024 or $30,000 for 2023 with catch-up contributions if allowed.
If you have multiple jobs, the contribution limit applies to your aggregated contributions, so keep this in mind.
401(k) Distribution Rules
Generally, distributions occur under one of the following:
- “You reach the retirement age of 59½ or experience a financial hardship
- You die, become disabled, or otherwise have a severance from employment
Distributions may occur nonperiodic (lump-sum) or periodically (installments), depending on the plan.
Note that 401(k)s have required minimum distributions (RMDs). The “required beginning date is April 1st of the first year after the later of the following years:
- Calendar year in which you reach age 72 (70½ if you reach age 70½ before January 1, 2020)
- Calendar year in which you retire”
Outside of general distribution rules, there are other situations that are considered qualified distributions and avoid penalties and taxes.
Those scenarios include:
- Costs related to purchasing a primary residence
- Payment of educational expenses, such as tuition and room and board for your spouse, dependents, or yourself
- Payments necessary to prevent being evicted from your primary residence
- Medical expenses incurred by your spouse, dependents, or you
- Funeral expenses
To learn more about these situations and more, click this link. Reviewing your 401(k) plan will also give you a better understanding of such scenarios.
Key Benefits Of A Traditional 401(k)
1. Contributions Are Tax-Deductible
Your contributions are tax-deductible, meaning your contributions lower your taxable income. This can be great for many reasons.
This could result in a lower tax bill if you usually owe at the end of the year. If you typically get a refund, this could increase it.
As a best practice, speak with your tax consultant to better gauge where you’ll end up on this spectrum since it may be vastly different from the next person’s.
2. Company Matches
Many companies, in an attempt to attract qualified employees, offer matching contributions, which is literally free money.
Some companies match upwards of 5%, if not more, and this match can only further grow your nest egg.
It’s not uncommon for companies to require a year or years of service before the company match goes into effect, so keep this in mind, too.
3. Investment Gains Are Tax-Deferred
A 401(k) grows tax-deferred, meaning you aren’t taxed on investment gains during your working years, which is great!
Frankly, this may be one of the most significant benefits of contributing to a traditional 401(k) and should be a huge incentive alone.
Since you’ll pay taxes during retirement, it’s possible to end up in a lower or higher tax bracket, which will be nearly impossible to estimate many years before.
4. You Can Take Your 401(k) With You
Many are unaware that you can rollover your 401(k) into another once you stop working for an employer.
You won’t be able to continue making contributions to a 401(k) with a previous employer. For this reason, it could be worth it to rollover a 401(k) into your existing one for the sake of convenience.
Even if you’re taking a break from working, many brokerage firms can house 401(k)s, which can help with managing your 401(k).
Penalties & Taxes For Unqualified Distributions
Even if you haven’t retired yet or meet any of the qualified distribution exceptions, you can still withdraw funds from your 401(k); however, it will come with penalties.
Such a withdrawal is considered an unqualified distribution and is subject to income tax and may be subject to an additional 10% tax.
The penalty discourages early, unqualified distributions; however, you may find the withdrawal necessary in certain cases.
Factors To Keep In Mind About A 401(k)
Factors to remember about a 401(k) are vesting schedules, taxable distributions, and investment limitations.
Companies must allow you to be fully vested (100%) in your elective deferrals, and this is outlined in the vesting schedule.
A vesting schedule also outlines the number of years you must be employed before matching contributions are yours to keep.
Since contributions are tax-deductible, distributions and earnings are taxable income during retirement.
A 401(k) will come with pre-determined investment options, most of which are often mutual funds (actively and passively managed).
If you work for a publicly traded company, it’s likely that company stock will also be an investment option.
In terms of reach, your options will be broad as you’ll typically have U.S. and international exposure.
Your investment options may also change occasionally, so it’s worth reviewing your investment selection annually.
Should You Contribute To A Traditional 401(k)?
Yes, especially if your company offers a match! Simply put, everyone needs a nest egg; the earlier you start, the better.
Having a nest egg will allow you to take that extra trip abroad every year, eat out whenever you feel like it, and even move to another country, if that’s ever in your plans.
And, more importantly, it’s never too late to get started! Even if you’re in your 30s or late 40s, you should strive to contribute to a 401(k) if that’s the retirement plan offered to you.
Needless to say, you have much more to lose by not contributing to a 401(k) since surviving on Social Security alone can be extremely challenging.
Final Thoughts
The 401(k) has helped many turn their retirement dreams into reality, and this will continue to be the case for many years to come.
The truth is, assuming it’s a 401(k) plan your employer offers, you cannot afford to not contribute to a 401(k).
While you realize some benefits now, you realize the greater portion of those benefits during your golden years, the years you spend work-free.
Even if you’re working during your golden years, you want it to be because you want to, not because you have to.
As you age, you’ll want to spend your time doing activities you enjoy and making every day feel like a weekend.
Are you contributing to a 401(k)? Why or why not? What do you find to be the most beneficial of a 401(k)?
Let us know your thoughts in the comment section below as we always look forward to reading what you have to say.
Thank you for reading, and remember to Stay Financially Invested!
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