401k investment calculator

What is a 401(k)?

A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account. 401(k) plans are named after the section of the tax code that governs them, Section 401(k).

These plans offer several benefits, including tax advantages, potential employer matching contributions, and automated savings that make it easier to build retirement savings over time.

Traditional vs. Roth 401(k)

There are two main types of 401(k) plans: Traditional and Roth. Understanding the differences can help you decide which is best for your situation:

• Traditional 401(k): Contributions are made with pre-tax dollars, reducing your current taxable income. Your investments grow tax-deferred, and you pay income tax on withdrawals in retirement.
• Roth 401(k): Contributions are made with after-tax dollars, so they don’t reduce your current taxable income. Your investments grow tax-free, and qualified withdrawals in retirement are completely tax-free.

Generally, a Traditional 401(k) may be better if you expect to be in a lower tax bracket in retirement, while a Roth 401(k) may be better if you expect to be in a higher tax bracket.

Employer Matching

Many employers offer matching contributions to your 401(k) plan. This is essentially free money that can significantly boost your retirement savings. Common matching formulas include:

• Dollar-for-dollar match: Employer contributes $1 for every $1 you contribute, up to a certain percentage of your salary.
• Percentage match: Employer contributes a percentage of your contributions, such as 50% of your contributions up to 6% of your salary.
• Non-matching contributions: Some employers make contributions to your 401(k) regardless of whether you contribute, though this is less common.

It’s important to contribute at least enough to get the full employer match, as not doing so means leaving free money on the table.

401(k) Contribution Limits

The IRS sets annual limits on how much you can contribute to your 401(k) account. These limits are periodically adjusted for inflation:

• Employee Contribution Limit (2023): $22,500 for those under 50
• Catch-up Contribution (2023): Additional $7,500 for those 50 and older
• Total Annual Contribution Limit (2023): $66,000 (including employer matching)

These limits are for combined contributions to all 401(k) plans you may have in a single year. If you exceed these limits, you may face tax penalties.

Investment Options in 401(k) Plans

401(k) plans typically offer a range of investment options, which may include:

• Target-Date Funds: Funds that automatically adjust their asset allocation based on your expected retirement date.
• Index Funds: Funds that track market indices like the S&P 500, offering broad market exposure with low fees.
• Actively Managed Funds: Funds managed by professionals who try to outperform the market.
• Company Stock: Some plans allow you to invest in your employer’s stock.
• Stable Value Funds: Conservative options that aim to preserve capital while providing modest returns.

Diversifying your investments across different asset classes can help manage risk while pursuing growth.

401(k) Withdrawal Rules

Withdrawing money from your 401(k) comes with specific rules and potential penalties:

• Early Withdrawals: Taking money out before age 59½ typically results in a 10% penalty plus income taxes on the amount withdrawn.
• Exceptions: Some exceptions to the early withdrawal penalty include financial hardship, disability, certain medical expenses, and first-time home purchases (up to $10,000).
• Required Minimum Distributions (RMDs): You must start taking withdrawals from your Traditional 401(k) by April 1 following the year you turn 73 (as of 2023).
• Roth 401(k) RMDs: Roth 401(k)s are also subject to RMDs, but you can avoid them by rolling the account over to a Roth IRA.

It’s generally best to leave your 401(k) money untouched until retirement to maximize its growth potential and avoid penalties.

401(k) Rollovers

When you change jobs, you have several options for your 401(k) account:

• Leave it with your former employer: Some employers allow you to keep your 401(k) with them after you leave.
• Rollover to your new employer’s 401(k): You can transfer the funds to your new employer’s plan if they accept rollovers.
• Rollover to an IRA: You can transfer the funds to an Individual Retirement Arrangement (IRA), which may offer more investment options.
• Cash out: You can take the money as a lump sum, but this will typically result in taxes and penalties if you’re under 59½.

Direct rollovers (where the funds are transferred directly between financial institutions) are generally the best option to avoid taxes and penalties.

401(k) Loans

Some 401(k) plans allow participants to borrow money from their account balance. Key points about 401(k) loans include:

• Loan Limits: You can typically borrow up to 50% of your vested account balance, with a maximum of $50,000.
• Repayment Terms: Loans must be repaid within 5 years, with exceptions for home purchases.
• Interest: You pay interest on the loan, but the interest goes back into your 401(k) account.
• Risks: If you leave your job (voluntarily or involuntarily), the loan typically must be repaid in full within a short period or it will be considered a distribution with taxes and potential penalties.

While 401(k) loans can provide access to funds in an emergency, they should be used cautiously due to the potential impact on your retirement savings.

Maximizing Your 401(k)

To get the most out of your 401(k) plan:

• Contribute Enough for the Full Match: At minimum, contribute enough to get your employer’s full matching contribution.
• Increase Contributions Over Time: Aim to increase your contribution rate each year, especially when you receive a raise.
• Diversify Your Investments: Spread your contributions across different asset classes based on your risk tolerance and time horizon.
• Review and Rebalance: Regularly review your investment choices and rebalance your portfolio to maintain your desired asset allocation.
• Minimize Fees: Pay attention to the fees associated with your investment options, as high fees can significantly reduce your returns over time.

Remember that your 401(k) is a long-term investment vehicle. Stay focused on your retirement goals and avoid making impulsive decisions based on short-term market movements.