How does a 401k/403b work?

A 401k is a business retirement account. The rules for your 401k are found in the SPD (Summary Plan Document) that is provided to all employees who qualify to participate. An employee can contribute the lesser of $18k ($24k if age 50+) or the pay from that employer each year (2016 figures). 401k’s may include a profit-sharing component. Your employer may choose to make matching contributions on part of your $18k employee contribution (ex: 100% of the first 3% and 50% of the next 4%). Always contribute enough to your 401k to get your full employer match – after all, that’s free money!

A profit-sharing arrangement allows the employer to contribute up to another $35k per employee based upon the profits of the company and the employee’s earned income. This contribution is discretionary, which means contributions are not mandatory for the employer.

You can have multiple 401k accounts if you have multiple employments in companies without common ownership. For example, you can work at a hospital and have a 401k and set up a separate 401k for income you earn moonlighting or in a second business you own on your own or with partners. Your employee contribution for the year can total only $18k/$24k from all accounts combined. In other words, if you have already contributed $18k at your hospital job, you must earn at least $265k from your second business to be able to contribute the maximum $53k (20% of earnings) into the profit-sharing component of your 2nd 401k.

Contributing the maximum to your 401k account(s) does not keep you from contributing the maximum to a personal retirement account, or IRA (Individual Retirement Account).

Get tips on evaluating your 401k/403b here.

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