The 401(k) – multi-headed beast that it is – can be slain.
But to do so you need to understand what kind of beast it is. Let’s take a look at the terms you’ll come across as you seek to educate yourself about the 401(k) in all its forms.
Making sense of the various jargon associated with the 401(k) will help you make much smarter decisions that will pay off financially in the long run.
And here they are!
Matching Rate
This is the amount your employer matches your contributions with. It’s based on a dollar-for-dollar principle and measured by percentage. So if your employer gives you a 90% contribution, they match every dollar you pay into the account with $0.90.
Matching Limitation
Companies, understandably, place a limit on how much money they will match your contributions with. Otherwise financial pandemonium might occur if employees decided to contribute every spare cent they could afford – or not.
To understand the matching limit, take your yearly earnings and apply the company limit – which is usually a small percentage below 10%.
If you earned $80,000 in a year, and your employer’s matching rate were 100% with a matching limit of 5%, then that would equal $1 for every dollar of the first 5% of $80,000.
5% of $80,000 = $4,000 and the matching rate of 100% means a full $4,000 matching limit.
If the matching rate were 80%, then that would be $0.80 for every dollar.
5% of $80,000 = $4,000 and a matching rate of 80% means 80c per dollar. 80% of $4,000 = $3,200.
That doesn’t mean you can’t contribute above the matching limit, but you won’t receive matching contributions. Nor can you contribute above the 401(k) contribution limit.
Contribution Limit
The government put a limit on how much you can squirrel away just in case you want to buy a James Bond villain HQ beneath the sea in Jamaica. Or else they just like to collect as much tax as possible. You decide.
Contributions to your 401 are a looked upon as a tax deduction. In other words, you are taxed on your salary after your contributions have been deducted.
Hardship Withdrawals
These are also called hardship loans, and they are what they say. Should you fall into hardship and need financial assistance you can borrow against your 401(k). Be aware that what constitutes a hardship can vary according to state, and if you don’t stick to the rigid schedule for paying back the loan you will face significant penalty taxation.
Vesting
Being fully vested in your 401k means that if you leave employment you take your employer’s matched contribution with you. Usually there is a vesting period after which this is allowed. For example, if your vesting period were 10 years and you left after 5, you would be 50% vested – and so entitled to 50% of your employer’s 401(k) contributions.
Employers do this to make it more attractive to stay with them than to leave, so it’s always worth considering this when you are thinking of looking for work elsewhere. If you are unhappy where you work, this isn’t an attraction, so much as a restraint.
Rollover
Should you change employers and the new company also offers a 401k program, you may move from your current 401(k) plan to the new one. This is called a rollover. You don’t necessarily have to roll it over to the new 401(k), but can roll it over into an IRA which is likely to have better investment options.
Terms You Just Learned
- Matching Rate
- Matching Limitation
- Contribution Limit
- Hardship Withdrawal
- Vesting
- Rollover
Your Next Steps
If any of these terms have made you think twice about your current 401(k), then speak to your employer about increasing your payments.
Understand the effects of vesting if you are planning to change job – and if so, start a Roth 401(k) or IRA now to rollover your savings for maximum benefit.
Good stuff!
Take control,
Manny
GRAB IT NOW