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How a 401k works

What is a 401(k)?

What is a 401(k)?

A 401(k) is an employer-sponsored plan for retirement savings. It allows employees the benefit of having retirement savings taken out of their paychecks before taxes. 

There are two kinds of 401(k) plans: a traditional 401(k) and a Roth 401(k). Both are employer-sponsored retirement savings plans, but they are taxed in different ways.

The IRS allows up to $19,000 per year in contributions to a 401(k) as well as an additional $6,000 in catch-up contributions as of 2019. 

Some employers are willing to "match" the contributions you make to your 401(k) up to a certain percentage of your wages. Take advantage of this match as it is free money!

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Have a 401(k) with an old employer?

Have a 401(k) with an old employer?

If so, you have a few options...

  • Leave it with your previous employer 
  • Transfer it to your new employer's 401(k) plan
  • Rollover the assets of your old 401(k) into an IRA
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Traditional vs Roth

Traditional vs Roth

A Traditional 401(k) offers tax benefits on the front end. Your money goes in tax-free, but you pay taxes on your contributions, employer match (if you have one), and the growth when you make withdrawals in retirement. Contributing to a Traditional 401(k) may be therefore fit your needs if you believe that you will be charged a lower tax rate during retirement than you are being charged now.

A Roth 401(k) offers tax-free growth. What does that mean? Your contributions are after-tax, but then you don’t pay taxes on your contributions or their growth when you retire. You will still owe taxes on employer contributions. Contributing to a Roth 401(k) may be therefore fit your needs if you believe that you will be charged a higher tax rate during retirement than you are being charged now.

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