Q: Our employer has what seems like a fairly good 401(k) plan - they match the first 4 percent of our salary that goes into the plan. However, I'm concerned because you can't participate in the plan after you leave the company. Does that mean I lose what I put into it, or have to pay a tax penalty for taking money out before I reach retirement age?
A: You can leave an employer-sponsored 401(k) retirement savings plan without incurring a tax penalty, but you should be aware of possible consequences if you switch your job or leave your employer. Overall, 401(k) participation is probably a good deal for you.
Retirement savings accounts like 401(k) plans allow you to delay paying taxes on any portion of your salary put into the plan until after retirement. You also don't pay taxes on investment gains until then. This allows your investments to compound earnings prior to taxation. In many cases, people are in lower tax brackets when they retire than they were in their peak earning years.
An even bigger advantage is when there is an employer match. This provides an instant return on your money, and with a dollar-for-dollar match on the first 4 percent of your salary that you contribute, your employer is offering a return that could take you years to accumulate through stock market investments, and is exponentially higher than today's tiny savings and money market rates. So, between the tax benefits and a generous employer match, there are clear incentives for you to participate in your employer's 401(k) plan.
Potential consequences for 401(k) retirement savings after leaving employer
As for the consequences of leaving your current company, leaving the 401(k) plan does not mean leaving behind what you put into the plan, nor does it require incurring tax penalties. If you promptly roll the proceeds over into a qualified retirement plan like a traditional IRA, you do not incur the usual 10 percent penalty for early withdrawals from a retirement plan, and you will continue to defer normal income taxes until retirement.
However, there may be adverse consequences to leaving with respect to the employer match. Some plans require employees to remain for a specified number of years before they become vested in the amounts the employer has contributed to the plan on their behalf. If you leave before the required number of years, you may have to leave behind some or all of the amount your employer contributed.
It's a good idea to check for a vesting requirement when you first sign up for the plan, rather than potentially raise red flags by looking into it if you are thinking of leaving a few years down the road.
Still, even if there is a vesting requirement, you have more to gain than to lose from 401(k) participation. Depending the plan design and how soon you leave the employer, you might have to sacrifice some of those matching dollars, but that is money you would not have in the first place if you did not participate in the plan.
Do you have a 401(k) retirement savings plan through your employer? Add your experience with 401(k)s to the conversation in the comments section below.
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