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Understanding traditional 401k plans

It's never too soon to begin saving for retirement. Your company's 401k plan is an easy way to get started.

Couple seated with paperwork

It's never too soon to begin saving for retirement. And if you're working, your company 401k plan is an easy way to get started.

A 401k is an employer-sponsored retirement plan that allows you to set aside part of your salary, before taxes are taken out, to save for your retirement.

Although you'll probably find information at work about how to start saving, we're here to help, too. Here's some information to help you learn more about Traditional 401k plans.

Who is eligible?

Many businesses offer 401k plans to eligible employees. Typically, an eligible employee is someone over the age of 21, who has been with the company at least one year and has worked for at least 1,000 hours in that year. A business may make their plan's eligibility rules less restrictive based upon their own demographics and objectives.

How does an employee contribute to the plan?

Once a 401k plan is set up, employees can elect to make contributions from their paycheck in one of two ways: before paying federal income taxes or after-tax as a Designated Roth Contribution (if elected by the company). If Designated Roth Contributions are made available in the plan, employees generally pay tax on those contributions when they are made, but don't owe tax on the money when it is withdrawn.

What are contribution limits?

In 2021, the maximum contribution that employees can make is $19,500 with an additional $6,500 if they are age 50 or older. The employer can also make additional contributions for all eligible employees. Any investment earnings within the plan grow tax-deferred until the funds are withdrawn in retirement.

What are employer contributions?

Employers do not have to contribute to the 401k plans that they offer, but most do. Some choose to contribute a flat amount of money for all eligible employees, some contribute a percentage of the eligible employees' compensation, and others match the eligible employees' contribution based upon an established formula.

The employer's contributions may vest over time, meaning that the employee may have to stay with the company for several years in order to receive the full amount when withdrawn from the plan.

Withdrawals are usually not allowed until the employee leaves the company. When that happens, the employee can generally roll the funds into a Traditional IRA without paying taxes. If the employee decides to withdraw the money and receive the funds directly, then income taxes on the contributions and earnings will generally have to be paid along with a 10% penalty tax if the employee is under age 55.

Some employers allow employees to take loans against the funds in their 401k plans and may also allow for withdrawals for hardship circumstances. If you are eligible to participate in your employer's 401k plan, consult the Summary Plan Description for details on the plan's provisions and benefits.

The information in this article was obtained from various sources not associated with State Farm® (including State Farm Mutual Automobile Insurance Company and its subsidiaries and affiliates). While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. State Farm is not responsible for, and does not endorse or approve, either implicitly or explicitly, the content of any third party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. State Farm makes no guarantees of results from use of this information.

Neither State Farm nor its agents provide tax or legal advice.

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