PC-ES 401k Plans PC1372-Print

RETIREMENT PLANNING

401(K) PLANS

What You Need to Know About 401(k) Plans

One of the most popular types of employer-sponsored retirement plans is the 401(k) plan. HOW DOES A 401(K) PLAN WORK? With a 401(k) plan, you elect either to receive cash payments (wages) from your employer immediately, or defer receipt of a portion of that income to the plan. The amount you defer (called an “elective deferral” or “pretax contribution”) isn’t currently included in your income; it’s made with pretax dollars. Consequently, your federal taxable income (and federal income tax) that year is reduced. And the deferred portion (along with any investment earnings) isn’t taxed to you until you receive payments from the plan. Example: Melissa earns $100,000 annually. She contributes $15,000 of her pay to her employer’s 401(k) plan on a pretax basis. As a result, her taxable income is $85,000. She isn’t taxed on the deferred money ($15,000), or any investment earnings, until she receives a distribution from the plan. You may also be able to make Roth contributions to your 401(k) plan. Roth 401(k) contributions are made on an after-tax basis, just like Roth IRA contributions. Unlike pretax contributions to a 401(k) plan, there’s no up-front tax benefit, but qualified distributions from a Roth 401(k) account are entirely free from federal income tax. WHEN CAN I CONTRIBUTE? You can contribute to your employer’s 401(k) plan as soon as you’re eligible to participate under the terms of the plan. In general, a 401(k) plan can make you wait up to a year before you’re eligible to contribute. But many plans don’t have a waiting period at all, allowing you to contribute beginning with your first paycheck. Some 401(k) plans provide for automatic enrollment once you’ve satisfied the plan’s eligibility requirements. For example, the plan might provide that you’ll be automatically enrolled at a 3% pretax contribution rate (or some other percentage) unless you elect a different deferral percentage, or choose not to participate in the plan. This is sometimes called a “negative enrollment” because you haven’t affirmatively elected to participate – instead you must affirmatively act to change or stop contributions. If you’ve been automatically enrolled in your 401(k) plan, make sure to check that your assigned contribution rate and investments are appropriate for your circumstances. HOW MUCH CAN I CONTRIBUTE? There’s an overall cap on your combined pretax and Roth 401(k) contributions. You can contribute up to $18,000 of your pay ($24,000 if you’re age 50 or older) to a 401(k) plan in 2016. If your plan allows Roth 401(k) contributions, you can split your contribution between pretax and Roth contributions any way you wish. For example, you can make $10,000 of Roth contributions and $8,000 of pretax 401(k) contributions. It’s up to you. But keep in mind that if you also contribute to another employer’s 401(k), 403(b), SIMPLE, or SAR-SEP plan, your total contributions to all of these plans – both pretax and Roth – can’t exceed $18,000 ($24,000 if you’re age 50 or older). It’s up to you to make sure you don’t exceed these limits if you contribute to plans of more than one employer. CAN I ALSO CONTRIBUTE TO AN IRA? Yes. Your participation in a 401(k) plan has no impact on your ability to contribute to an IRA (Roth or traditional). You can contribute up to $5,500 to an IRA in 2016, $6,500 if you’re age 50 or older (or, if less, 100% of your taxable compensation). But, depending on your salary level, your ability to make deductible contributions to a traditional IRA may be limited if you participate in a 401(k) plan. WHAT ARE THE TAX CONSEQUENCES? When you make pretax 401(k) contributions, you don’t pay current income taxes on those dollars (which means more take-home pay compared to an after-tax Roth contribution of the same amount). But your contributions and investment earnings are fully taxable when you receive a distribution from the plan. In contrast, Roth 401(k) contributions are subject to income taxes up front, but qualified distributions of your contributions and earnings are entirely free from federal income tax. In general, a distribution from your Roth 401(k) account is qualified only if it satisfies both of the following requirements:  It’s made after the end of a five-year waiting period  The payment is made after you turn 59½, become disabled, or die The five-year waiting period for qualified distributions starts with the year you make your first Roth contribution to the 401(k) plan. For

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