How Much of Your 401 (K) Balance Actually Belongs to You?
If you have contributed to a 401 (k) or IRA for several years, you might like your current balance. You know you will have to pay some taxes when you receive your payout, but that is overshadowed by the progress you are making towards your retirement goals. See what kind of wealth you are creating!
Unfortunately, your true balance can be significantly lower than what your account shows when you sign in. There are two reasons for this: the aforementioned taxes and the vesting period.
When planning your retirement and considering financial decisions, it is important to understand how much money you will actually have to spend in retirement.
Vest
Vesting applies to funds contributed by your employer to your retirement fund. Although your contributions are 100 percent yours (you made money), employer contributions often have a vesting schedule: you can get 20 percent of the contributions every year for five years (called a partial or graded allocation) or 100 percent after a certain period. an amount of time, say a year (known as the vestments from the cliff).
In theory, this should encourage employees to stay with the company and do their jobs well. But it does mean that, for example, if you calculate that your five percent employer matches your retirement balance, you might have to do a different math.
“Unfinished amounts can be confiscated by employees when the account balance is paid to them (for example, when an employee leaves the job) or when they have not worked more than 500 hours a year for five years,” the IRS notes . …
This means that if you are not currently fully protected, your 401 (k) balance may not reflect how much money you actually have.
“Your balance sheet may show the fully committed employer contribution, only to have your balance adjusted to reflect the amount you received when you quit your job or renew your plan,” says Go Banking Rates .
This will depend on your employer and plan provider. For more clarity, ask HR what your balance sheet reflects.
Tax
In theory, we all know that we have to pay taxes on our 401 (k) or IRA money when we receive our retirement payout. These accounts allow us to defer paying taxes (and taxes on investment income) for decades, making them worthwhile investment vehicles. But how much should we expect to “lose”?
This chart from the 2016 Federal Reserve Consumer Finance Survey , first published in Marketwatch , sheds some light on the situation.
As you can see, the estimated tax rate, although it can vary, can severely cut your savings, depending on how much you earn and how much you save. The 401 (k) distribution is taxed as regular income, meaning if you took a $ 20,000 distribution and were, for example, in the 22 percent tax bracket , you would have $ 15,600.
In addition, as CNN Money points out, “Social Security benefits will not be taxed if your income is below a certain threshold, but getting 401 (k) distributions could push you to that limit, so your benefits will become taxed.” This is the second tax hit that you may not be considering right now.
And, unlike vesting, there is no time limit. You will be in debt regardless of the maneuvers you take (even if you transfer your account to Roth, you will be charged taxes during the conversion ). Be sure to take this into account when planning your retirement plan.