Retirement plans and expectations vary greatly for each person, so the amount you need to retire and the method to reach that goal is unique and personal. One popular way to reach a retirement savings goal is with a 401(k) plan. Some estimate that 79% of Americans work for a company that offers 401(k) plans. September 8th is the National 401(k) day, so it’s a good time to revisit your retirement plan to see if you are on track. For example, according to some surveys, for those approaching retirement, age 55-64, the average amount in a 401(k) plan is only slightly over $250,000.

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The 401(k) plan received its name when Congress passed the Revenue Act of 1978. The act included a provision that was added to the Internal Revenue Code — Section 401(k) — that allowed employees to avoid being taxed on certain deferred compensation arrangements.

The usage of 401(k) plans has grown extremely fast since its inception. The Employee Benefits Research Institute has put together a timeline with some interesting facts and rule changes that can be found here, but two statements really demonstrate the growth:

In 1984, six years after its inception – “Number of plans with a 401(k) feature (according to U.S. Department of Labor Form 5500 reports): 17,303. Number of active participants in these plans: 7,540,000. Total assets in these plans: $91.75 billion.”

In 2015, thirty-seven years after inception – “Number of plans with a 401(k) feature: 546,896. Number of active participants: 65,307,000. Total assets: $4.38 trillion.”

This retirement savings approach is continuing to grow in popularity for employers and employees every year, yet it is still underutilized, with only about 50% of those with access contributing. Here are some basics to help you get started or to consider as you evaluate your current participation in a plan:

The employer match

Some employers will match contributions, or a percentage of contributions, up to a specific amount. For example, an employer might match 50% of contributions up to $5,000, meaning that if an employee defers $5,000 for the year, the employer will contribute $2,500. A failure to save enough to trigger the full employer match is sometimes referred to as “leaving money on the table,” because the employee receives the bonus in their retirement account simply by contributing a specific amount.

Accessing the plan funds

You always have access to the funds in your 401(k), but there are some issues that come with taking it out early. The first and foremost is that you must pay a 10% tax penalty on any funds received before age 59 ½, and the second is that early withdrawals are subject to state and federal income taxes (taxes were deferred on the contributed income, so the taxes must be paid when you take it out). The penalty tax might be avoided for certain “hardship withdrawals,” but the income tax must always be paid.

Although you have access to the money anytime, it can be advantageous to let it grow as much as possible. An alternative that participants may consider is to take a loan from their 401(k) account that they repay later, if the employer plan permits such loans. This approach provides immediate liquidity, but there are penalties if the loan is not repaid. Plus, growth opportunities are lost while the money is out of the account.

Traditional vs. Roth 401(k) plans

Roth 401(k)s were introduced in 2006, and have become more popular in recent years as more plans began offering this feature. With a traditional 401(k) account, the contributions are pre-tax, so you have more funds to contribute. With a Roth 401(k) account, there is no immediate tax benefit, but the investment gains are potentially tax-free.

Because you’ve already paid taxes on contributions to a Roth account, there is also no penalty to take out your contributions at any time (there is a five year rule and an age rule regarding withdrawal of the earnings). Starting in 2024, there won’t be required minimum distribution rules for Roth 401(k) accounts, based on changes from the SECURE Act 2.0.

Investment choices

Every 401(k) plan is required to provide investment choices to its participants that satisfy a full range of investment choices. It’s important to understand what your risk tolerance is and what your time horizon is when making investment decisions. If you work with an Arvest Client Advisor, they may consider your 401(k) investments within the broader picture of your regular investment portfolio to understand all the risks you’re taking. The 401(k) funds will be labeled and the plan provider can provide additional information. There may also be target date funds aligned with your retirement date that are automatically adjusted to the common risk tolerance for that age bracket.

Contribution limits

In either a traditional or Roth account, or between the two of them, you can contribute up to $22,500 per year in 2023, or $30,000 if you are age 50 or older.

New laws regarding 401(k) plans

Secure Act 2.0 made several minor changes to 401(k) plans.  Many of the changes are already going into effect and are good for participants, such as the higher age for Required Minimum Distributions (or eliminating the RMDs for Roth 401(k) accounts in 2024 as mentioned above) and higher catch up contributions for those age 60 through 63. There are also other features that will make it easier for employers to encourage employee participation, such as matching eligible student loan repayments. More hardship withdrawals are allowed for those in specific challenging circumstances. Soon, employees will also start being auto-enrolled in retirement plans with the option to opt-out.

Since it is national 401(k) day, it’s a good time to get started saving or consider increasing your contribution amount.

If you’re an employer considering adding a 401(k) plan or wondering if a different type of retirement plan might be more suitable for your business, Arvest’s Retirement Plan Consulting team would be pleased to go over the options with you. Please contact us for more information.

This content has been prepared by The Merrill Anderson Company and is intended as a general guideline.

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Arvest Wealth Management does not offer tax or legal advice – consult licensed professionals for advice.