Six Common 401(k) Plan Misconceptions
As more Americans shoulder the responsibility of funding their own retirement, many rely increasingly on their 401(k) retirement plans to provide the means to meet their investment goals. That's because 401(k) plans offer a variety of attractive features that make investing for the future easier and potentially profitable.
Do you really know as much as you think you do about your 401(k) plan? Let's find out.
- If I leave my job, my entire 401(k) account is mine to keep. This may or may not be true, depending on your plan's "vesting schedule." Your own contributions to the plan, that is, your pretax or Roth contributions are always yours to keep. While some plans provide that employer contributions are also fully vested (i.e., owned by you) immediately, other plans may require that you have up to six years of service before you're entitled to all of your employer contributions (or you've reached your plan's normal retirement age). Your 401(k)'s summary plan description will have details about your plan's vesting schedule.
- Borrowing from my 401(k) plan is a bad idea because I pay income tax twice on the amount I borrow. The argument is that you repay a 401(k) plan loan with dollars that have already been taxed, and you pay taxes on those dollars again when you receive a distribution from the plan. Though you might be repaying the loan with after-tax dollars, this would be true with any type of loan. And while it's also true that the amount you borrow will be taxed when distributed from the plan (special rules apply to loans from Roth accounts), those amounts would be taxed regardless of whether you borrowed money from the plan or not. So the bottom line is that, economically, you're no worse off borrowing from your plan than you are borrowing from another source (plus, the interest you pay on a plan loan generally goes back into your account).It is important to remember that borrowing from your plan reduces your account balance, which may slow the growth of your retirement nest egg. Retirement can be expensive, and you want to make sure you have saved enough money to cover living expenses in your later years when you will need it the most. Before making the decision to borrow from your 401(k) plan, consider speaking with an HCM Wealth Advisor to discuss alternative means of paying your debts.
- Because I make only Roth contributions to my 401(k) plan, my employer's matching contributions are also Roth contributions. Employer 401(k) matching contributions are always pretax, whether they match your pretax or Roth contributions. That is, those matching contributions, and any associated earnings, will always be subject to income tax when you receive them from the plan. You can, however, convert your employer's matching contributions to Roth contributions if your plan allows. If you do, they'll be subject to income tax in the year of the conversion, but future qualified distributions of those amounts (and any earnings) will be tax free.
- I contribute to my 401(k) plan at work, so I can't contribute to an IRA. Your contributions to a 401(k) plan have no effect on your ability to contribute to a traditional or Roth IRA. However, your (or your spouse's) participation in a 401(k) plan may adversely impact your ability to deduct contributions to a traditional IRA, depending on your joint income.
- I have two jobs, both with 401(k) plans. I can defer up to $18,000 to each plan. Unfortunately, this is not the case. You can defer a maximum of $18,000 in 2015, plus catch-up contributions if you're eligible, to all your employer plans (this includes 401(k)s, 403(b)s, SARSEPs, and SIMPLE plans). If you contribute to more than one plan, you're generally responsible for making sure you don't exceed these limits. Note that 457(b) plans are not included in this list. If you're lucky enough to participate in a 401(k) plan and a 457(b) plan you may be able to defer up to $36,000 (a maximum of $18,000 to each plan) in 2015, plus catch-up contributions.
- I'm moving to a state with no income tax. I've heard my former state can still tax my 401(k) benefits when I retire. While this was true many years ago, it's no longer the case. States are now prohibited from taxing 401(k) (and most other) retirement benefits paid to nonresidents. As a result, only the state in which you reside (or are domiciled) can tax those benefits. In general, your residence is the place where you actually live. Your domicile is your permanent legal residence; even if you don't currently live there, you have an intent to return and remain there.
A 401(k) plan can become the cornerstone of your personal retirement savings program, providing the foundation for your future financial security. If you have questions about your employer's 401(k) and other savings and investment plans, feel free to contact the Cincinnati retirement planning firm of Hengehold Capital Management. We'd be happy to help.
Article from Broadridge Advisor Solutions/Forefield (copyright 2015) and used with permission. Content in this article is not intended to be financial advice. Instead, we think of it as educational, and financial education is important to us.