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Updated: Jan. 28, 2021, 3:08 p..m. A 401(k) is a tax-advantaged retirement account usually offered by an employer. Employees can choose to set out a certain percentage of their salaries to their 401(k)s, and employers often correspond to some of these contributions. The different types of 401(k)s differ in eligibility requirements and how they are taxed. Here's everything you need to know when you're thinking of contribute to a 401(k). Benefits of a 401(k)Place your savings in a 401(k) grant many benefits. Here are some of the key ones: Tax savings: Contributions to traditional 401(k)s are made with pretax dollars, reducing your taxable income for the current year. The contributions are tax deferrals, meaning you instead owe taxes when you withdraw funds in retirement. If you're in a higher tax bracket today than you expect to be in retirement, deferring the tax liability could save you money. High contribution limits: 401(k) contribution limits are much higher than contribution limits for Individual Retirement Account (IRAs). Employer match: Employers often correspond to a percentage of their employees' contributions. It's like getting a bonus and reducing how much you need to save for retirement on your own. Automatic contributions: You can choose to set out a percentage of each salary to your 401(k), so you don't have to make retirement contributions manually. You can also change your contribution percentage at any time. Rollover: If you leave your employer, you can keep your retirement savings in your old 401(k) or roll over the funds in your new company's 401(k) or an IRA.401(k)s company-sponsored retirement plans, once you meet your company's eligibility requirements, you can enroll and decide how much of each salary you want to contribute. Some companies automatically enroll employees in their 401(k) plans. Check with your company's HR department to learn more about your plan. Explore Related Retirement Topics Retirement Plans Check out other retirement plans that may be right for you Here's a closer look at some of the rules that apply to 401(k) withdrawals. CarvingsYe may take money from your 401(k) at any time, but you will pay a 10% early withdrawal fine if you do so before the age of 59 1/2 unless you have a qualifying exception. Qualifying exceptions include large medical expenses, educational expenditure and first-home purchases, among other things. Required minimum distributions Require minimum distributions (RMDs) are mandatory distributions of 401(k)s that should start when you become 72. Before 2020, RMDs had to start at the age of 70 1/2. Calculate your RMD by dividing your 401(k) balance into this table by the distribution period next to your age. Failure to withdraw at least this very triggers a 50% fine annually on the amount you should have withdrawn. Adults ages 72 and older who are still working may delay RMDs from their current 401(k) until they retire, but if IRAs or old 401(k)s from former employers, they should still take their RMDs out of these accounts that at age 72.Rule of 55The Rule of 55 permits to take those who quit their jobs or are fired in the year they turn 55 or later to take penalty-free withdrawals from their 401(k)s, even if they are younger than 59 Public safety workers are eligible for penalty-free carvings as they leave their jobs after they become 50. You can only take penalty-free carvings of your most recent 401(k), not from other retirement accounts.401(k) loanSome 401(k)s enable participants to borrow money from their plans and repay them with interest over time. A loan of 401(k) may be a nice alternative to a traditional bank loan for some people, but withdrawing funds could slow the growth of your retirement savings. If you cannot repay the full amount you borrowed by the end of the loan term, the outstanding balance is considered a distribution and taxed accordingly. What are 401(k) limits? These are some of the main 401(k) rules and limits that you should be aware of if you plan to contribute to this type of account. Contribution limitsYy can contribute to $19,500 to a 401(k) in 2020 and 2021 unless you are age 50 or older, in which case you can make an extra catch-up contribution of up to $6,500. These contribution limits can change annually. Income limitsPeople classified by the IRS as highly compensated employees (HC's) - those who own more than 5% of the company they work for or earn more than $130,000 annually in 2020 and 2021 - may not be eligible to contribute to their 401(k)s to the maximum limits. Those in the top 20% of their company per income can also be classified as HCEs if their company chooses. Employers must conduct non-discrimination tests annually to ensure that DCs do not contribute significantly more money to their 401(k)s than non-HCEs. Long story short, average annual HCE contributions may not exceed non-HCE contributions by more than two percentage points. If they do, then HCEs are prohibited from contribute to the annual limits outlined above. Beneficiaries If you are married, you need your spouse's written permission to designate someone other than your spouse as your 401(k) beneficiary. Otherwise, you may accept any person you want to inherit your 401(k) when you die, provided that there are funds left in the account. If you do not name a beneficiary, the money usually goes to your estate. Review who you've designated as the account's beneficiaries at least annually. Divorce, birth or acceptance of children, and deaths in the family may all necessitate a change in the existing beneficiaries. 401(k)s come in several varieties. Most of the information above centers on tax deferrals 401(k)s, which are most common. But other types of 401(k)s include: Roth 401(k) This is much the same as a 401(k), except that contributions are made with after-tax dollars. Contributions to Roth 401(k)'s don't your taxable income for the current year, but is instead distributed tax-free in retirement. Employers offering corresponding programmes cannot contribute directly to Roth 401(k)s, and should instead contribute any corresponding funds to a traditional 401(k). Solo 401(k) A solo 401(k) is only available to self-employed people. This type of 401(k) effectively has higher annual contribution limits because you can contribute as an employee and employer. Inherited 401(k) Is an inherited 401(k) which receives a beneficiary when the original 401(k) owner dies. After transferring the account, the beneficiary may not contribute any new money to this account and must withdraw within a set number of years. If the original owner of the 401(k) was the beneficiary spouse, the beneficiary can roll it over in his or her own 401(k). Highly compensated employee 401(k) This is not a special type of 401(k). HCEs can contribute to the same 401(k)s as non-HCEs, though, as explained above, how much they can contribute can vary. Here's a closer look at how 401(k)s stack up against other common retirement accounts. IRA Anyone earning income could open an IRA and contribute up to $6,000 this year, $7,000 if they're 50 or older. These contribution limits are lower than 401(k) limits, but IRAs also give you more freedom to invest how you choose, and they can also have lower fees. 403(b) A 403(b) is similar to a 401(k) but is only available to certain ministers, public school employees and employees of tax-exempt organisations. Contribution limits are the same as for 401(k)s, but employees who have worked for their companies for at least 15 years can contribute up to $3,000 a year to a 403(b). 457(b) A 457(b) plan is a type of retirement account only available to state and local governments and some nonprofit employers. Contribution limits are the same as for a 401(k), but a 457 plan allows for more catch-up contributions for those 50 and older, and there are no penalties for withdrawals made before 59 1/2. 401(a) 401(a) plans are another option commonly offered by governments, public schools, and non-profits. Participation in a 401(a) is often compulsory, and the employer determines how much of each employee's salary is taken into account. These plans are highly customizable, and contribution limits are the same as 401(k) limits. Pension pensions provide a guaranteed source of monthly income in retirement, while 401(k)s do not. Also employers fund pensions, while employees primarily fund their own 401(k)s, although employers may choose to match some contributions. Pensions are rare today; employers usually choose to offer 401(k)s instead. For many Americans, the balance of their 401(k) account is one of the largest financial assets they own - but the money in these accounts isn't always accessible as there are restrictions on when you have access to it. 401(k) plans are meant to help you for retirement, so if you have 401(k) 401(k) before 59 1/2 you generally owe a 10% early withdrawal bid on top of ordinary income tax. However, there are limited exceptions. For example, if you incur invalid medical expenses that exceed 10% of your adjusted gross income, you can withdraw money from a 401(k) penalty-free to pay it. Similarly, you can take a penalty-free spread if you are a military reerfish called to active duty. Because the exceptions are narrow, most people should leave their money investing up to 59 1/2 to avoid incurring substantial tax costs. However, there is one major exception that could apply if you're an older American who needs access to 401(k) funds earlier. It's called the rule of 55, and here's how it can work for you. Image source: Getty Images. What is the rule of 55? The rule of 55 is an IRS regulation that allows certain older Americans to withdraw money from their 401(k)s without incurring the customary 10% penalty for early withdrawals made before 59 1/2. The rule of 55 applies to you as: You leave your job in the calendar year that you will become 55 or later (or the year you will turn 50 if you are a public safety worker, such as a police officer or air traffic controller). You can leave for any reason, including because you were fired, you were laid off, or you quit. You only withdraw funds from a 401(k) account offered by your most recent employer. You can't withdraw money fine-free from accounts with other previous employers, nor can you make penalty-free withdrawals from an IRA, even if you've rolled over your 401(k) into one after leaving your most recent job. One common misconception is that you can leave your job before the calendar year you 55 become and the rule will still apply to you. That's not the case. If you 55 become in 2021 and leave your job December 31, 2020, the rule does not apply to you. How to make the best use of the rule of 55 The limitations of arranging 55 make it essential to use smart planning techniques. First of all, you need to time your early retirement so you don't leave your job before the year in which you'll 55 become. Secondly, if you want to maximize the amount of money you can withdraw without penalties, you should take advantage of overrodes to move as much money as you can into your current employer's 401(k) before leaving your job. For example: Many companies allow you to roll over 401(k)s from old employers into your new employer's account. Many also enable you to move money from an IRA to your workplace 401(k) if the money came into the IRA when you rolled over an old workplace 401(k). Any money in your current employer's 401(k) account when you leave your job will qualify for arranging 55, so using rollovers to put as much money into that account as possible offers you the most flexibility. If you don't roll the money from old 401(k)s or IRAs in current 401(k) rollover before you leave, you will not have the option to withdraw without punishment until age 59 Finally, remember not to roll over your eligible 401(k) account in an IRA after quitting at 55 or older. Doing so will cause you to lose the exemption and subject you to penalties for withdrawals until you hit 59 1/2. Have access to money is vital for retirees, especially if you eventually have to retire early or unexpectedly. Knowing the rules to access your 401(k) at 55 or older can be a lifesaver for your finances. Finance.

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