In this blog series of 401(k) plan info., we’ve covered the basics of what a 401(k) plan is and what types of contributions can be made. In addition, there are other rules and guidelines that participants should be familiar with.

Vesting

Vesting is a term used to describe the point at which a 401(k) plan participant is entitled to 100% of the employer matching contributions in his or her retirement account. The participant is, of course, always entitled to 100% of his or her own contributions, but employer matching contributions are typically subject to a vesting schedule, ranging from three to seven years. The purpose for the vesting schedule is to encourage employees to remain with the employer. The 401(k) plan document and your employer can tell you what your plan’s vesting schedule is.

Here’s a brief example. Let’s say Suzy Smith contributes to her 401(k) plan and her employer matches her contributions up to 50%. The employer has selected a 5 year vesting schedule for the plan, with Suzy being vested 20% each year. Her vesting would look like this:

After year 1:  20% vested in employer matching contributions
After year 2:  40% vested in employer matching contributions
After year 3:  60% vested in employer matching contributions
After year 4:  80% vested in employer matching contributions
After year 5:  100% vested in employer matching contributions

401(k) Withdrawals

Before contributing to a 401(k) plan, you want to be familiar with the ways in which you can withdraw your money. To an extent, those conditions will be dictated by your 401(k) plan document. Here are the acceptable withdrawal methods:

– Loans
– Hardship withdrawals
– Termination of employment
– Retirement
– Disability
– Death

401(k) Loans

Not all 401(k) plans allow loans, but those that do will require repayment. Loan payments, including interest and principal, are repaid directly to the employee’s 401(k) account. The plan document will specify if the plan allows loans, and if so, what conditions apply.

401(k) Hardship Withdrawals

Some 401(k) plans have provisions for hardship withdrawals, allowing a participant to withdraw contributions within certain limits and for specific reasons. Those reasons typically include medical expenses, the purchase of a home, college tuition for the next 12 months or to prevent eviction or foreclosure from the employee’s primary residence. Again, the plan document will specify any rules that apply.

Termination of Employment

When a 401(k) plan participant leaves an employer by quitting or being fired, he or she is entitled to the vested balance in his or her 401(k) account. The plan document will specify how and when this withdrawal takes place. To avoid adverse tax consequences, the participant should speak with his or her financial advisor to determine if a rollover to another retirement plan like an IRA is appropriate.

Retirement Distributions

401(k) withdrawals made at retirement age are called distributions. Before age 59 1/2, distributions are taxable and generally subject to a 10% penalty. After age 59 1/2, lump sum distributions will be taxed and current income tax rates, but the distributions may be eligible for special 10-year averaging tax treatment. Money can also be withdrawn and rolled over to another qualified plan, IRA, 403(b) or 457 plan. For additional information about these options, participants should talk to their financial and tax advisors.

We’ve covered a lot of 401(k) info. in the last three blog posts, but there is still so much more to know. If you are investing in a 401(k) plan, or are considering it, and have questions, please contact us. We can help you navigate the ins and outs of your 401(k) plan and make recommendations based on your financial situation.

Thanks for reading!

Joe Maas, CFA, AVA, CFP®, ChFC, CLU®, MSFS, CCIM
President of Synergetic Finance