A 401k can be an essential part of your retirement strategy. These plans allow employees to contribute a specific portion of their salaries to the program, which employers have the option to match.
The contributions you make to your 401k are then invested in stocks, bonds, and mutual funds, helping them grow over time. The hope is that your 401k ends up providing you with enough money to retire on in the future because of the gains it makes.
There are also tax benefits associated with 401k plans, as you typically won’t pay tax on the amount you invest until after retirement. A Roth 401k is the opposite, though, as you’ll pay tax now but not on your withdrawals.
Every person’s retirement goals are different and require individual planning, but there are some basic guidelines everyone should be aware of when implementing a 401k strategy. This guide will take you through some 401k rules of thumb that can point you in the right direction as you plan for your future.
An Overview of Some Basic 401k Rules
It’s wise to learn some 401k rules before you begin investing, as this knowledge ensures you’re making informed decisions. The goal is to invest enough money right now to provide a comfortable retirement later, but some regulations provide a framework. Here’s what you should know:
You’ll have to pay tax on your 401k contributions, either now or later. Traditional plans allow you to deduct your contributions from your taxable income and pay the tax when you withdraw it. Roth 401ks, on the other hand, permit you to keep your current taxable income the same to avoid paying tax in retirement. Either way, you’ll have to pay tax on any employer match contributions you receive when you remove the money.
You can’t withdraw any money from your traditional 401k until you’re 59.5 years old, or you’re responsible for a 10% early withdrawal fee. That penalty doesn’t apply to Roth contributions. Other exceptions to this rule include SEPP payments, the Rule of 55, qualifying medical expenses, disability, 401k loans, and qualified domestic relations court orders.
You can’t put as much money as you want into your 401k every year because rules limit the contributions you can make. You’re only permitted to contribute $19,500 to your plan in 2021, but that number increases to $26,000 if you’re 50 or older. Your total contributions, including the amount your employer contributes, are capped at $57,000 per year, or $63,500 for anyone 50 and up.
Required Minimum Distributions
You’ll have to begin making annual withdrawals from your 401k account by the time you’re 72 years old. The exact amount you’ll have to remove from your account depends on how much money you have available and your life expectancy. Required minimum distributions do not apply to Roth 401ks because you’ve already paid tax on the money.
Learning some basic rules before developing a retirement strategy makes it easier to understand where you’re heading. This information makes it more likely you can take full advantage of everything these plans offer while avoiding potential problems and penalties.
4 Retirement 401k Rules of Thumb to Remember
Every retirement plan is different because it depends on when you want to retire, how much money you’re making right now, and your retirement goals. There are some 401k rules of thumb to remember, though, as they’ll make it easier to create a framework to follow. Here’s a look at four of them:
1. You’ll Need 80%
One decades-old 401k rule of thumb is that you’ll need 80% of your current income to live on once you retire. It’s worth noting that this rule is based on the idea that you’ll be mortgage-free once you retire, which may or may not be possible. Some families might need more while others can get by on less, but the 80% rule creates a starting point as you plan for retirement.
2. Retirement Starts at 65
Many people wait until 65 to retire for one reason: Medicare. Retiring before you’re 65 years old could mean you’re no longer on your company’s health insurance plan, but you won’t be covered on Medicare until you reach that age. It’s advisable to plan your retirement around this age unless you have some other way to secure health insurance in the meantime.
3. The 4% Rule
Those who take 4% of their retirement capital every year starting at age 65 are unlikely to outlive their funds. The 4% rule takes inflation into account, too, but you should know it also uses past market performance. A sudden stock market crash as you approach retirement or after you’ve already retired could put you in a challenging situation.
4. 100 Minus Your Age
It’s often a good idea to reduce your exposure to equities as you age because you might not have time for the market to recover. Enter the “100 minus your age” rule, which suggests limiting the percentage of stocks you’re holding in your retirement fund to a number equal to 100 minus your current age. An investor who is 77, therefore, should only have 23% of their investments in stocks.
These 401k rules of thumb don’t necessarily apply to every situation because countless variables are at play. They are easy-to-remember strategies, though, that can assist as you make decisions on the fly or meet with experts while planning your financial future.
Every Retirement Is Different, so You Need Expert Guidance
Only you know your exact retirement goals, so while these 401k rules of thumb can provide a baseline, you’ll want to develop a plan that matches your future aspirations. Meeting with a retirement planning expert can provide insight into the best way to reach your goals.
Bogart Wealth is a team of financial and wealth management advisors who can assist as you plan for the next stage of your life. We offer investment management and retirement planning services as well. Contact Bogart Wealth today to learn about your best financial options moving forward.