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Retired Military Finances 101: 401(k) plans. A Lot Like TSP, But Not the Same

Retirement Funding

You're about to hang up your uniform one last time. You've been lucky with the job hunt and you have more than a few good prospects out there. Most of them have a 401(k) plan. What do you need to know about them.

A 401(k) is a retirement savings plan that is oftentimes part of many company’s benefits package. This plan enables you to defer money from your paycheck to be put into a 401(k) investment account. In addition to your personal contribution, many companies will also put money into your 401(k), "matching" a portion of your allocation. 

Usually, there will be a pre-set amount that is deferred from your paycheck, but you can alter how much you want to put into your 401(k). You may choose to dial the amount up or down depending on your financial situation and your company’s offerings. For example, if your employer matches exactly what you put in and you are financially stable, you usually will want to contribute as much as you can might to your 401(k). 

Understanding your company’s 401(k) plan is the first step to making the most of it.

Discover What Plan(s) Your Company Offers

Traditional Pre-Tax 401(k)

With a traditional 401(k), you save on taxes now in two ways. First, since your reported salary is reduced by the amount put into your account, you’ll pay fewer income taxes. Second, the money inside the account grows tax-deferred, so you don’t have to pay tax on the gains each year. You’ll only pay tax on the amount you withdraw during retirement.

Roth 401(k)

With a Roth 401(k), contributions are made with after-tax dollars, and you do not pay on the amount withdrawn during retirement. Unlike the traditional 401(k), you’ll save on taxes in the future rather than in real-time. With this plan, you do not reduce your earned income by the amount contributed to your account. There are a couple of things you need to realize when it comes to Roth 401(k). First of all, unlike Roth IRAs, there is no income limit for contributions. So even if you can't contribute to a Roth IRA, you'll be able to contribute to a Roth 401(k). Second, any employer matching will go into a tax deferred account and distributions from that portion of your 401(k) will be taxable.

Contribution Limits

For the tax year 2020, the contribution limit will be $19,500 per individual. If you have multiple plans, the combined contributions are capped at $19,500.1 You'll want to watch out for this the year you retire from the military so that you don't go over the limit. For those over age 50 you can contribute an additional $6,500 a year (starting in 2020)

Choosing the Right 401(k) Plan for Your Situation

If your employer offers both a pre-tax 401(k) and a Roth 401(k), you’ll have to decide which plan is right for you. You’ll pay taxes on a pre-tax 401(k) when withdrawing, but you’ll pay taxes on Roth 401(k) contributions now, and this difference will play a role in choosing the best plan for your needs.

Retired Senior Military Officers and NCOs will likely be in a high tax bracket while working. This may push you towards a pre-tax 401(k). Plus, tax laws can change and a deduction today may be worth more than promised tax-free treatment in the future (Once upon a time all Social Security Benefits were tax free. They're not anymore).

Should You Also Open an IRA?

Aside from your employer’s 401(k) plan, you have the option to open a Traditional Individual Retirement Account (IRA). However, based on your income, the contributions to a Traditional IRA may not be deductible. As alluded to above, if your income is too high, you won't be able to contribute to a Roth IRA directly. 

Understand Your Investment Options

Many plans will allow you to choose between multiple types of investments, like different mutual funds. You’ll want to thoroughly explore these options and consider which one is fitting for your circumstances. 

Is Your Employer Contributing to Your 401(k)?

In many scenarios, your employer will also contribute to your 401(k). These contributions are pre-tax, so you’ll only pay taxes on the money when it’s withdrawn in retirement. There are several types of employer contributions:

1. Matching

With a matching employer contribution, your employer contributes a percentage (up to 100%) of your contribution, normally up to some limit. A typical matching formula is 100% of the first 3% contributed plus 50% of the next 2% contributed. 

2. Non-Elective

A non-elective employer contribution means that your employer will put in the same percentage for every employee, even if the employee is not contributing. 

3. Profit-Sharing

In a profit-sharing 401(k), employers will delegate a percentage or dollar amount of the company’s profit to employees’ 401(k) accounts. 

Find Out When Your Employer Contribution Dollars Are Yours

Frequently, an employee can only keep its employer’s contributions after a certain number of years in the company, otherwise known as “vesting.” When you’re vested after a certain number of years, you now own the contributions made by your employer. 

If you want to make the most of your employer’s plan, you’ll want to find out when you are vested. You may decide to part ways with your job only after you are vested, allowing you to take full advantage of your company’s 401(k) plan. 

Once you understand the specifics of your company’s 401(k) offerings, you’ll be able to decide how to make the best of the plan for your needs and goals. 

Military Finances Are Different

If you're a military retiree, there are a lot of nuances when it comes to your financial plan. We think you should work with an financial advisor that works with active and retired military members each and every day. If you'd like to find out more about our services, give us a call.

  1. https://www.irs.gov/newsroom/401k-contribution-limit-increases-to-19500-for-2020-catch-up-limit-rises-to-6500

If you found this article useful, you might like the following blog posts:

Working in the Gig Economy After Military Retirement: What You Need to Know


I'm About to Retire From the Military. What Should I Do With My TSP?


It's Here! New TSP Withdrawal Options Available



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