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By Bill Bischoff
A 401(k) can be a glorious thing, but let’s not forget that these plans are regulated by government bureaucrats. That means they are rife with rules and regulations. Here are answers to some of the more common questions we get about 401(k)s.
How much can I contribute?
For 2016, the cap for salary-reduction contributions is generally $18,000. But that’s not the only limit. The total amount contributed by both you and your employer can’t exceed $53,000. If, however, you’ll be age 50 or older by the end of the year, the contribution limits are higher: $24,000 and $59,000 respectively. That said, if you’re a “highly compensated employee,” your contributions could be limited to lower numbers, regardless of your age. (See next question.)
I’ve been labeled a “highly compensated employee.” What does that mean?
According to the 2016 rule book, that means you make more than $120,000 a year. The IRS doesn’t want 401(k) plans to favor a company’s top brass. Consequently, employers must make annual assessments to ensure that their highly compensated employees (HCEs), like you, aren’t contributing a far greater percentage of their salaries to the 401(k) plan than the rank-and-file workers. So if the employees who earn less than $120,000 a year at your company are contributing to the 401(k) plan at a lower rate than HCEs like you, expect your contribution limits to be lowered.
Should I roll over my 401(k) from my old employer to my new employer’s program or into an IRA instead?
There aren’t a whole lot of reasons to roll your 401(k) into another 401(k) instead of rolling the funds into your own IRA. The main exception is if you want to be able to borrow from the account. Most 401(k) plans allow you to borrow from the account (potentially up to $50,000), while this is strictly forbidden for IRAs. More on this issue later.
Rolling your 401(k) into an IRA instead should give you significantly more control over the money. That’s because you can pretty much invest it how you see fit. After all, there are thousands of mutual funds out there, while the average 401(k) plan only offers a few investment options. Unless you feel strongly about having all your retirement account money in one place, a good strategy is to roll your old 401(k) into a self-directed IRA and then contribute as much as you can to the 401(k) at your new job. Even if the new plan is worse than your old one, you don’t want to forsake the benefit of pretax contributions and the company match.
No matter what, though, make sure you do a direct trustee-to-trustee transfer when rolling over your 401(k) account into another company plan. That way, you avoid automatic 20% withholding for federal income tax.
How long can a company legally hold onto contributions until they are deposited in my account?
Legally your employer must deposit your money no later than 15 business days after the end of the month. This means that it could take as long as six weeks from the time the money is withdrawn from your paycheck before it turns up in your 401(k). Think your employer is doing something fishy? You can file a complaint with the Department of Labor.
Can I borrow from my 401(k)?
Most plans do allow you to borrow from your 401(k). And it can be tempting. (After all, you’re borrowing from yourself.) You can generally borrow half your vested balance or $50,000, whichever is less. But think long and hard before tapping this nest egg. Employers often halt your match while a loan is outstanding. And if you get laid off, fired or leave the job for any other reason, chances are that that loan is going to be called in, and fast. What happens if you can’t repay the loan? You’ll owe income taxes plus a 10% early withdrawal penalty if you are under age 55.
At what age can I tap my 401(k)?
Generally speaking, you have to wait until age 59 1/2 to tap your account without getting hit with the 10% early-withdrawal penalty. But if you’re age 55 or older and you permanently leave your job, then you can begin tapping it immediately without owing the 10% penalty. This is called the “separated from service” exception. It doesn’t matter if you quit, retire or are fired. In fact, you could even begin working someplace else. But remember: Even when the 10% penalty doesn’t apply, you’ll still owe income taxes on your withdrawals.
What are hardship withdrawals?
Under certain circumstances, some companies will allow you to permanently withdraw money from your 401(k), even without leaving your company. But unless you really, really have to, it’s a bad idea. That’s because you’ll generally owe income taxes plus a 10% early withdrawal penalty if you are under age 59 1/2. A company can determine its own definition of “hardship,” but many use what are called the “safe harbor rules” which allow withdrawals for the following reasons:
- To pay medical expenses
- To cover the down payment or to avoid eviction or foreclosure on your primary residence
- To pay college tuition
- To cover funeral expenses for a family member