401k Rules

There are quite a few 401k rules governing this type of retirement investment account. This page will discuss the most important rules so you understand your options and what you can and cannot do in regards to your retirement savings.

Eligibility

Of the 401k rules, this is probably the most important and the simplest rule. If you have a job, you are eligible to invest in an employer sponsored 401k. If you are self-employed your only option is an IRA.

Contributions

The 401k rules surrounding contributions are also rather simple.

401k Contribution Method: You may only contribute to your 401k via payroll deductions. You may not write a check or use any other funding source.

401k Contribution Limits: At the time of this writing, your maximum contribution is $16,500 per year if you are under the age of 50. If you are over 50, you can make an additional contribution of up to $5,000 per year.

Taxes

Your 401k is a tax-deferred retirement account. In other words, you will save on payroll taxes every year up until you start taking distributions. The contributions will come off the top of your salary and the remainder will only be subject to payroll taxes. However, you will have to pay taxes on the contributions and interest earned when you take out the money.

Loans and Withdrawals

The 401k rules also allow for taking loans and withdrawals from your retirement account. These rules only apply to people that are under 59 ½ years old.

Loans: Most plans allow you take out a loan from your retirement account for any reason. You will have to repay these loans or pay a 10% tax penalty and have to pay taxes on the loan amount. You can have a maximum of $50,000 or 50% of your balance whichever is smaller. Often you will have to pay interest on the loan, but the interest payments are credited back to your 401k account.

Withdrawals: Most plans allow for withdrawals under certain circumstances. These withdrawals come with a 10% tax penalty and you will have to take the amount of the withdrawal as income during the current year. These withdrawals have to be for an allowed reason. The reasons include: foreclosure of your primary residence, purchasing a primary residence, and medical bills that exceed a certain percentage of your annual income.

Rollover

When you leave a job that included an employer sponsored 401k, you may rollover the funds into another approved retirement account without penalty or taxes. An approved account may be your new employer’s 401k or any form of an IRA.

Vesting

The last of the 401k rules covers vesting. The only documented rule is an employee must be 100% vested into their own contributions and the interest earned on those contributions at all times. In other words, your money cannot be forfeited to anyone for any reason.

However, if your employer offers matching contributions it is up to them to determine when the matching portion will be vested. The only criterion that has to be met is the employer must deposit the funds into a trust and they must document when the funds will become vested. In addition, they cannot change their vesting rules for existing employees.