Know Your 401(k) Tax RulesReviewAdviceFAQ's

Know Your 401(k) Tax Rules

A 401(k) is a tax-deferred, defined-contribution pension plan, meaning that you make contributions from your pre-tax income and pay taxes only when you cash out your retirement account. IRS tax rules for retirement accounts differ in general, depending on your income, fiscal brackets, employer and contribution limit.

What are the Eligibility Rules?

401(k) eligibility varies by company, so contact your organization's human resources department to learn more about internal procedures. Some businesses would want you, a new employee, to wait for six or 12 months, but it is not unusual to see a company grant you eligibility status upon hire.

Know Your 401(k) Tax Rules

How Much Can I Contribute to my 401(k)?

Contribution limits differ every year, depending on Internal Revenue Service stipulations. For 2013, the IRS announced that you can contribute up to $17,500 to your 401(k) and other retirement schemes, such as the U.S. government's Thrift Savings Plan, 403(b) and most 457 plans. The contribution limit is $23,000 if you are 50 years or older.

Would My Employer Match Contributions?

Yes. Most employers typically match 100% of your contribution, up to 3% of your gross income – and this is called the primary matching schedule. In a secondary matching schedule, some employers may consent to match a specific percentage, say, 50%, of employee contributions, up to a specified percentage. Check with your company's HR department to get more information about the organization's matching policy. Employer contributions are a great giveaway, so try to maximize them by contributing as much as you economically can. Use this tool to figure out the best way to maximize your company's 401(k) contribution match.

How Long Do I Wait for Contributions to Vest?

Depending on the company, the employer's matching contribution can take up to six years to "vest," meaning to become yours. In other words, the money the company allocates to your 401(k) does not belong to you for a certain period. If you leave the company before the end of the vesting period, you would lose the employer's matching contribution. Note that you never lose your own contributions, no matter where you work.

Can I Cash out My 401(k)?

The IRS allows hardship withdrawals if you are coping with financial tumult and have provided ample detail about your economic situation in an explanatory letter, often called "hardship letter." If you withdraw cash before the mandated age of 59 ½, you pay a 10% penalty.

How Can I Avoid Early-Withdrawal Penalties?

If you change jobs, make sure you roll over your 401(k) investments into an Individual Retirement Account; otherwise, the IRS would tax your 401(k) balance as ordinary income. The agency also has mandated that your employer automatically roll over 401(k) balances ranging from $1,000 to $5,000 into an IRA if you depart the company. If you hold more than $5,000 in your 401(k), the IRS allows you to keep your account in your former employer's 401(k) plan.

How Can I Withdraw My Money, Penalty-Free?

You can make a 401(k) withdrawal, or complete cash out, as soon as you retire or by April 1 of the year after you turn 70 ½, whichever event comes the latest.


Knowing the tax rules pertaining to 401(k) can help you the somewhat steep 10% penalty and withdraw your funds when it is legally and economically sensible to do so. Contact your company's 401(k) Plan administrator for more information about eligibility, contribution and withdrawal procedures.

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