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Understanding 401(k) Plans: A Comprehensive Guide

At O1ne Mortgage, we believe in empowering you with the knowledge to make informed financial decisions. If you have any mortgage-related needs, feel free to call us at 213-732-3074. In this article, we will explore the ins and outs of 401(k) plans, a popular retirement savings option.

How Does a 401(k) Work?

A 401(k) is a retirement savings plan offered by many employers. Contributions are made directly from your paycheck, making it easier to save consistently. These contributions are tax-deferred, meaning you won’t pay taxes on them until you withdraw the funds in retirement. This can be a powerful way to grow your retirement savings.

Types of 401(k)s

There are several types of 401(k) plans:

• Traditional 401(k): Funded with pretax dollars, reducing your taxable income now. Taxes are paid upon withdrawal in retirement.
• Roth 401(k): Funded with after-tax dollars. Withdrawals in retirement are tax-free, which can be beneficial if you expect to be in a higher tax bracket later.
• SIMPLE 401(k): Designed for small businesses with fewer than 100 employees.
• Solo 401(k): Ideal for self-employed individuals with no other employees.

Why Should You Invest in a 401(k)?

Investing in a 401(k) offers significant tax advantages. Contributions lower your taxable income now, and if your tax bracket is lower in retirement, you can reduce your overall tax liability. Additionally, automatic payroll deductions make it easier to save consistently. Many employers also offer matching contributions, which is essentially free money for your retirement.

401(k) Contribution Limits

For the 2023 tax year, the IRS limits annual employee contributions to $22,500. Those aged 50 and older can make an additional $7,500 in catch-up contributions, bringing the total to $30,000. Employer matching contributions do not count toward this limit, but the combined total from both you and your employer cannot exceed $66,000 ($73,500 for those 50 and older) or 100% of your compensation, whichever is less.

How Much Should I Contribute to a 401(k)?

It’s generally wise to contribute at least enough to take full advantage of any employer match. Beyond that, aim to contribute as much as you can while balancing other financial goals. Many experts recommend contributing 10% to 15% of your paycheck each month.

How to Withdraw Funds From a 401(k)

There are two types of withdrawals: qualified distributions in retirement and early withdrawals. Qualified withdrawals can be made after age 59½ without penalties. Early withdrawals before this age typically incur a 10% penalty and are subject to income taxes. If you face a serious financial need, you may qualify for a hardship withdrawal, but it’s best to avoid early withdrawals if possible.

Qualified Withdrawals in Retirement

To withdraw funds in retirement:

• Wait until at least age 59½ to avoid penalties.
• Be aware of required minimum distributions starting at age 72 (or 70½ if born before July 1, 1949).
• Contact your plan administrator to initiate withdrawals.
• Plan for taxes, as withdrawals will be subject to ordinary income taxes.

Early 401(k) Withdrawals

Early withdrawals before age 59½ incur a 10% penalty and are subject to income taxes. If you face a serious financial need, you may qualify for a hardship withdrawal. Check IRS guidelines to see if you qualify.

The Bottom Line

Investing in a 401(k) is an excellent way to save for retirement. Take full advantage of any employer match and consider making annual contributions up to the amount you can afford. For personalized advice, consider consulting a financial advisor.

For any mortgage-related needs, call O1ne Mortgage at 213-732-3074. We’re here to help you achieve your financial goals.

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