Learning is a science. Before your brain can really comprehend a concept, it first needs a solid foundation. Understanding 401(k)s is no different! Building your vocabulary will help you fully absorb concepts related to this excellent retirement plan option. Below are a few common terms to get you started.
Familiarize Yourself With These 401(k) Terms
1. Tax Deductible
You’ve likely heard that standard 401(k) contributions are tax-deductible, but what does this really mean? Tax deductible is just a fancy way of saying something can be subtracted from your income before calculating the amount you owe in taxes. By removing it from the equation, you will end up owing less. Note that there are limits to how much you can contribute tax free. This amount can change on a yearly basis and your age is factored into how much you can contribute as well (see the “catch-up contributions” section below).
Keep in mind that since 401(k) contributions are made with pre-tax dollars, you will have to pay taxes on these funds when you withdraw them later in life.
Matching refers to an employer making contributions to your 401(k) account, the amount of which is based on a set percentage and on what you yourself contribute. Some employers match 100% of your contributions (with limitations). For this reason, you may stand to gain more by contributing more yourself.
The sky is often not the limit when it comes to 401(k) matching. An employer may only match 100% on up to 5% of your income. Say you make $70,000 a year and contribute $4,000 to your 401(k). If your employer matches 100% up to 5% of your income, they will contribute $3,500 (5% of $70,000 is $3,500). Their contributions will never exceed this threshold.
3. Vested Funds
Vested refers to how much employer-contributed funds you can take with you after leaving a job.
Because 401(k) retirement plans are tied to your employment, your employer may hold back some of the funds they contributed if you leave the company under certain conditions. For example, your account may be fully vested after 5 years. If you leave prior to 5 years, you will only receive a percentage of the employer-contributed funds. However, the whole pot is yours if you stay for at least 5 years!
4. Catch-Up Contribution
A catch-up contribution is an additional contribution made by an individual aged 50 or older. As the name suggests, this gives you the opportunity to “catch up” and make up for years you did not save as much as you would have liked.
There are limitations to catch-up contributions. Refer to the IRS website to learn more.
5. Required Minimum Distribution (RMD)
You can’t leave your funds in a 401(k) account forever! By age 72 you have to start taking out required minimum distributions every year until your account balance is depleted. The IRS offers online worksheets to help you calculate your RMD.
Here at General Electric Credit Union (GECU) our goal is to support you at every stage of life. That’s why we offer retirement calculators and investment services that set you up for a successful future. For the latter, a CUSO Financial Services, L.P.1 advisor will sit down and discuss your goals and dreams – including options for retirement plans! From 401(k)s to other retirement savings vehicles, they’ll help you determine the best option for your needs.
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1Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a Registered Broker-dealer (Member FINRA/SIPC) and SEC-registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. General Electric Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union member