Understanding 401K
What is a 401K plan?
A 401(k) plan is a retirement savings plan offered by many American employers that has tax advantages to the saver.The employee who signs up for a 401(k) agrees to have a percentage of each paycheck paid directly into an investment account. The employer may match part or all of that contribution.
How does a 401K plan work?
The 401(k) plan was designed by the United States Congress to encourage people to save for retirement who are working for US employers in the USA.
They are of basically two types :
- Traditional 401(k) : With a traditional 401(k), employee contributions are deducted from gross income, meaning the money comes from the employee’s payroll before income taxes have been deducted. As a result, the employee’s taxable income is reduced by the total amount of contributions for the year and can be reported as a tax deduction for that tax year. No taxes are due on the money contributed or the earnings until the employee withdraws the money, usually in retirement.
- Roth 401(k) : With a Roth 401(k), contributions are deducted from the employee’s after-tax income, meaning contributions come from the employee’s pay after income taxes have been deducted. As a result, there is no tax deduction in the year of the contribution. When the money is withdrawn during retirement, no additional taxes are due on the employee’s contribution or the investment earnings.
How much can I contribute to my 401K plan?
The amount that an employee can contribute to their 401K plan varies year to year by the IRS.
For 2021, the annual limit on employee contributions is $19,500 per year for workers under age 50, and for 2022, the limit is $20,500 per year. However, those aged 50 and over can make a $6,500 catch-up contribution in 2021 and 2022.
In 2022, the employee’s personal 401(k) contributions will be $20,500 a year ($27,000 if you’re over 50). The limit for employee and employer contributions combined is: either 100% of your salary or $61,000 ($67,500 if you’re over 50), whichever comes first.
What is Employer Contribution in a 401K plan? How does it work?
An employer 401(k) contribution match is one of the best rewards to stay with your employer. An employer match is literally a cash benefit over and above your annual compensation that is deposited by the employer to your 401K account.
Every 401(k) plan is different. But there are two common types of matches:
Partial matching
Your employer will match part of the money you put in, up to a certain amount. The partial match provided by employers is 50% of what you put in, up to 6% of your salary. In other words, your employer matches half of whatever you contribute but no more than 3% of your salary total.
Dollar-for-dollar matching
With a dollar-for-dollar match (aka full match, aka 100% match), your employer puts in the same amount of money you do — again up to a certain amount. An example might be dollar-for-dollar up to 4% of your salary. In this case, if you put in 4%, they put in 4%; if you put in 2%, they put in 2%. If you put in 6%, they still only put in 4%, because that’s their max.
What is Vesting Schedule in a 401K plan?
A lot of employers use a vesting schedule for their 401(k) matches to help them reduce the amount of money they’d lose if an employee were to leave the company after a short term of employment and also to serve as an incentive for an employee to stay.
Under this plan while the employee owns all of the employee contribution to 401k at all times, however, a vesting schedule determines how much of the employer’s matching contributions an employee owns, based on the longevity of the employment.
There are 2 types of Vesting plans – Graded Vesting and Cliff Vesting. Under graded or gradual vesting, if your employer contributions vest gradually over four years, then 25% of your employer contributions belong to you after you’ve been there one year, 50% belong to you after two years, 75% belong to you after three years, and then a 100% once you hit your fourth work anniversary. If you exit the company at any time before the 4th anniversary then you sacrifice some of that money. On the other hand ‘Cliff Vesting’ is more of an all-or-nothing scenario. With a four-year cliff, 0% of the contributions are yours until you hit your fourth workiversary. Once the 4 year vesting period is complete then 100% of the contributions are available to the employees 401k account.
What does 401k look like at Groupsoft US Inc.?
Groupsoft believes in taking care of its employees with long term goals. With the intention to ensure for all its employees a secure and comfortable life post retirement, Groupsoft has established the following practices:
- An employee retains the choice to pick either the 401k or the Roth plan as per their personal preference.
- Groupsoft provides Dollar-for-Dollar Matching Contributions to its employees.
- Groupsoft does not follow a Vesting Schedule, all employees have to access the employer contributions from day one of participation in 401K Plan.
You can watch the below video if you want to know more about the 401K Plan:
