401(k)s are the best known retirement savings plans.
Similar to IRAs, there are traditional and Roth varieties of the 401(k). Traditional 401(k)s allow you to defer a percentage of your pre-tax income each pay period. Your contributions and any earnings you accrue grow tax-deferred. When you begin taking distributions, they're taxed at your ordinary income tax rate.
Roth 401(k)s offer some of the benefits of traditional 401(k)s and some of Roth IRAs. No tax is due on earnings as they accumulate. But unlike tax-deferred contributions, your contributions to a Roth are taxable in the year in which you make them. However, you'll never owe taxes on any accumulated earnings when you withdraw, as long as you're at least 59½ and the account has been open for at least five years.
Like individual retirement accounts, 401(k)s have annual contribution limits. Matching contributions from your employer don't reduce the amount you can add. However, you may encounter specific contribution restrictions depending on your salary and company regulations, so be sure to check with your employer about your specific limits.
Your plan may allow you to split your contributions between a traditional 401(k) and a Roth 401(k) if you prefer. You'll also find that matching contributions from your employer go into a traditional account even if your own contributions go into a Roth 401(k).
Investing Your 401(k)
When you invest the contributions you make to your 401(k), you choose among the alternatives offered through your plan. They typically include mutual funds, target date funds, stable value funds, managed accounts and company stock.
Some employers offer a brokerage account, also called a brokerage window, through which you can select a wide range of individual securities or funds. Other employers enroll everyone who is eligible in the plan and select a default investment for the contributions. If you're automatically enrolled, you have the right to switch out of the default to other plan offerings or opt out of participation entirely.
Traditional and Roth 401(k)s have the same distribution requirements. You may begin taking money out of your account as soon as you retire, but must begin taking required minimum distributions (RMDs) no later than April 1 of the year following the year you turn 70½. You can generally postpone taking distributions as long as you continue to work, unless you own 5% or more of the company.
An alternative to making withdrawals is to roll over your account value to an IRA. The balance of a traditional 401(k) can be transferred to a Traditional IRA, and the assets in a Roth 401(k) can be rolled over to a Roth IRA. If you decide to roll over, you must follow the withdrawal requirements for the IRA in which you're now invested.
For example, Traditional IRAs have the same RMD requirements as traditional 401(k)s. When you make a withdrawal from your IRA, distributions are taxed at your regular income tax rate. If you roll over to a Roth IRA, on the other hand, you no longer have any withdrawal requirements and may keep your money invested for as long as you want.
This material is for informational purposes only and Scottrade is not responsible for any errors or omissions. The information is subject to change without notice and should not be construed as a recommendation or investment advice. Please consult your tax or legal advisor(s) for questions concerning your personal tax or financial situation.