When it comes to 401(k) investing, there are some terms that every new investor should know before they open their mouth. One of those terms is “account balance.”
According to companies like SoFi, a 401(k) is a savings account that you contribute to and receive a tax break for when you withdraw the funds for investing. The more you contribute, the higher the initial account balance you receive, and the bigger your contribution room grows. (You get to keep it in an IRA, however, until you reach the full contribution limit.) Withdrawals are tax-free, too.
The initial 401(k) balance that you’ll receive depends on the amount of money you contributed and the year you make your contribution. (If you made your contribution in a prior year, you’ll get the older contribution amount.)
Basic 401(k) (pre-tax)
The total balance is tax-deferred for up to 10 years, depending on the timing of when you make your withdrawal. The 10-year rule applies only if you make contributions during the first 3 years of employment and you withdraw after the age of 59 1/2. Withdrawals are limited to 1% of your annual compensation. (For more information, read “What are your rights under the 401(k) plan if you leave your employer?”)
Traditional 401(k) (pre-tax)
You contribute money into a 401(k) plan based on your current compensation, with automatic deduction of 10% of your compensation, whether you receive a salary increase or not.
Optional Roth 401(k) (pre-tax)
You contribute up to a certain limit each year and are allowed a deduction for the money you contribute. You don’t have to contribute the full amount each year. You’re taxed only on the money you contribute in the year you do so. You may also be eligible for a bonus of up to $100 per month if you make 6 or more Roth contributions in a year. (For more information, read “My mom left my IRA and Roth IRA when I was 18.”)
The IRS explains that this number includes any contribution required for nonqualified distribution. (For more information, see “Other Retirement Plans.”)
If you make a new hire with a salary of at least $100,000, then your 401(k) is a traditional account with a “cost-of-living” increase (CPI) if you are between 50 and 59 1/2 and your new employer contributes at least 5% of your salary to your 401(k). If you make at least $200,000, then your 401(k) is a traditional account with a “cost-of-living” increase if you are between 50 and 59 1/2. (For more information, see “Tax and Retirement Planning.)
Your new employer may also require you to set up a new Traditional IRA.