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5 Ways to Get the Most Out of Your 401(k)

Published: October 2015

For many people, retirement feels like a long way away. But if you have an employer who offers a 401(k) plan, taking full advantage can be one of the easiest, and smartest, retirement moves you make.

Here are five ways to help you get the most out of your employer's 401(k) plan.

Young professionals meeting at table.

Understand How a 401(k) Works

As the Internal Revenue Service (IRS) explains, a 401(k) is a retirement savings plan sponsored by an employer. If you participate in a 401(k), a portion of your wages or salary is paid into a retirement plan. Your employer may also make an additional contribution. The IRS sets limits on the amount you can contribute to your 401(k) each year. Your employer may also set limits.

Although your plan administrator sets up your 401(k) plan, you can choose how to invest the money. Your plan will generally give you a number of investment options to choose from.

Investing in a 401(k) can have significant tax advantages, listed by the U.S. Department of Labor. You generally don't pay income tax on money you contribute to a traditional 401(k) until it's withdrawn, explains the Financial Industry Regulatory Authority (FINRA). Also, while your money is in a 401(k), you don't pay taxes on the income or capital gains your investments are earning for you.

Some employers may offer a Roth 401(k), which FINRA explains has different tax rules.

Start Saving As Early As Possible

You might think that while you're young, and on a starting salary, it's not worth trying to save for retirement. That can be a mistake.

The Securities and Exchange Commission says that time can be a critical factor in the returns you earn from your investment. Even if the amounts you can invest in a 401(k) seem small to you, they can make a big difference to your retirement fund if they're earning returns over decades.

Don't Pass Up Matching Contributions

Many employers match employee contributions to their 401(k) accounts. If you put a percentage of your salary into a 401(k), an employer might also put in a percentage, up to a certain limit.

FINRA puts it bluntly: "If you contribute less than your employer is willing to match, you may be passing up free money." If your circumstances allow it, you may want to consider making sure your 401(k) contribution meets your employer's matching limit.

The IRS explains that your employer's contributions may vest gradually, meaning those contributions may not belong to you until a certain period of time has passed. (Your own contributions are always 100 percent vested.) Check with your employer's HR department about matching contributions and any rules that may apply.

Avoid Withdrawing If You Can

Generally, you can't withdraw from a 401(k) before a specified age without a specific reason. The IRS lists some of them, which include suffering financial hardship (if your employer's plan allows hardship distributions). Certain medical expenses, burial and funeral expenses, and certain home repairs are examples of potential hardship withdrawals.

Avoid withdrawing from your 401(k) if you possibly can. Early withdrawals may set back your preparations for retirement, and are subject to penalty tax in many cases, according to FINRA.

In many cases, if you withdraw from your 401(k) early, you not only pay income tax on the withdrawal, but also an extra 10 percent penalty tax. (The IRS lists the exceptional situations where you can withdraw penalty-free.)

So whenever possible, it's best to leave your 401(k) balance alone to grow.

Reassess When You Change Jobs

When you change jobs, you might find yourself with two 401(k) plans — your new employer's and your old employer's.

Don't forget about your old 401(k) accounts — it's your money!

As FINRA notes, when changing jobs, your options may include withdrawing money from your old 401(k), leaving it where it is, rolling it over into the new plan, or rolling it over into an individual retirement account (IRA).

A 401(k) can be a valuable retirement preparation tool, and typically the earlier you start saving, the better off you'll be. A financial professional or an Allstate agent can help guide you as make decisions about retirement savings that are right for you.

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Please note that Allstate Life Insurance Company or its agents and representatives cannot give legal or tax advice. The brief discussion of taxes on this page may not be complete or current. The laws and regulations are complex and subject to change. For complete details consult your attorney or tax advisor

Securities offered by Personal Financial Representatives through Allstate Financial Services, LLC (LSA Securities in LA and PA). Registered Broker-Dealer. Member FINRA, SIPC. Main Office: 2920 South 84th Street, Lincoln, NE 68506. (877) 525-5727. Check the background of this firm on FINRA's BrokerCheck website.

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