401(k) could offer tax relief in saving for retirement

Question: What’s the difference between a 401(k), a traditional IRA and a Roth IRA?

Answer: 401(k) plans are employer-sponsored plans with many rules. Traditional and Roth IRAs are individual retirement accounts that anyone can open. Contributions to a traditional IRA are pretaxed while contributions to the Roth IRA are made with after-tax dollars.

Q: If you had a choice, is it better to choose 401(k) or Roth IRA? 

A: Every person’s situation is different. Some people are looking for tax relief, so the 401(k) could reduce your taxable income by possibly putting you in a lower tax bracket. On the other hand, the Roth IRA allows you to save with after-tax dollars, offers tax-deferred growth, and you can retrieve all of your investment tax-free after age 59. Some 401(k) plans now offer a Roth 401(k) component within the plan. Choosing one over the other really depends on the individual’s situation.

Q: Do most companies typically match contributions? If so, by how much? 

A: Not necessarily. 401(k) matching has become varied from company to company and can even change each year. The median match is about 3 percent, but it can be more or less depending on the generosity of the company. Some also offer a percentage based on the company’s profits at the end of the year, if any.

Q: What’s the maximum contribution you can put in a 401(k) each year?

A: A person younger than 50 years old can contribute up to $17,500 per year. The 50-plus crowd, they can put an additional $5,500 known as the "catch-up contributions" into their 401(k) for a total of $23,000 per year.

Q: What are the rules concerning 401(k) withdrawals? 

A: All 401(k) withdrawals are taxable as ordinary income. Additionally, if you are younger than 59, then you will be penalized 10 percent of the entire amount withdrawn. There are, however, some exceptions which allow you to withdraw without penalty, such as becoming disabled, if you terminate employment and are at least 55 years old. There have also been some updates to 401(k) plans that now allow you to roll over your 401(k) to an individual retirement account. This could give you more control over what you invest your retirement dollars in and monitor expenses of the investments chosen.

Q: When can you withdraw from a 401(k) without penalties? 

A: There are a couple of ways to get money out of 401(k) without penalties. One would be to borrow against the 401(k). Again, the plan document would say if this is allowed and what the limits would be. Usually, it is up to $50,000 or 50 percent of the balance of the account. It is, however, a loan and will be deducted from your pay for a time frame of one to 5 years from each paycheck. The other way to make a withdrawal is to reach the age of 59. Then, you have the option to roll it over into an individual retirement account or cash it out. Cashing it out will not incur a penalty, but the full amount withdrawn is taxable as ordinary income. It would be best to check with your tax adviser before making this type of decision.

Q: How much should mid-career workers be putting toward their 401(k) each month?

A: This is a tough question to answer. It’s like going to the doctor and asking for medicine without telling the doctor what your symptoms are. Basically, everyone is different. In order to determine the right amount, we would need to examine your whole financial picture and see what your goals are and what you have done so far in relation to your goals. Someone who has been a "saver" their entire life may not need to change much as a mid-career worker. On the flip side, if you haven’t made much of an effort to save in the early years, then your strategy would be completely different.