What You Need to Know About 401(K) in Canada

A 401(K) is a tax-deferred established retirement plan which allows employees to contribute a part of their salary towards retirement. 401(K) allows an employer to equal employee’s contribution to tax-deductible company contributions.

Notably, earnings on all contributions are permitted to grow in a tax-deferred trust. Also, if contributions were made by your employer while you were residing in the U.S, you will be permitted to transfer part of your payment from your 401(K) account. If your employer permits, you can transfer your 401(K) to a rollover IRA and then transfer the IRA to a Canadian RRSP.

Types of 401(K) Accounts

There are two major types of 401(K) accounts; the conventional 401(K) and the Roth 401(k) account. The Roth account is also known as a “designated Roth account.” The only difference between the two accounts is tax, they are both taxed differently. An employee can choose to run both accounts.

401(K) Benefits

As a Canadian resident, there are pros and cons involved in the 401k program you should know about. Some of the benefits of 401(K) include:

  • Convenience

It is easier to deduct money via automatic payroll withholding towards your retirement. You do not feel the impact of the money deducted as it feels the money was never there.

  • Free Money

With 401(K), your employer contributes also towards your retirement. Your employer’s contribution equals free money. This simply means more money for you after retirement.

Other benefits include; deferment of U.S tax on contributions, the prospect of contributing more toward 401(K) than IRA, lastly professional bodies handles your fund.

How to Contribute to Your 401(K)

To make contributions, an employer and employee must make contributions up to the dollar limit established by the Internal Revenue Service. As an employee, you are responsible for selecting the desired investment within the 401(K) accounts from the selection provided by your employer. Most of the selected options usually include a variety of stock and bond mutual funds.

An employee is responsible to give an employer any desired amount of money upon retirement. Employers now use 401(K) rather than the conventional pension scheme, it is easier, has minimal risk and safe.

401(K) Contribution Limit

The highest amount an employer or employee can contribute to a 401(K) plan is regularly adjusted to account for inflation. For a designated Roth 401(K) account, the maximum contribution for the year 2020 is $19,500, up from $19,000 that was established in the year 2019. Notably, account holders aged 50 or above may make catch-up contributions of up to $6,500, for a prospect of an overall annual contribution of $26,000.

The cap, including employer and employee contribution, amounts to $57,000 to $63,500 for employers aged 50 and above. Catch-up payments are additional contributions that help employees close to retirement age to surge up the account in the years before the funds will be needed for regular income.

Withdrawing From A 401(K) Plan

Always have it at the back of your mind that once you contribute to a 401(k) plan, it may be difficult to withdraw your money without a penalty. With the traditional account, once a withdrawal is made, the tax-free money will be taxed as ordinary income. For Roth account owners, they must be aged at least 59½ or meet other criteria stipulated by the IRS like being totally and permanently disabled when they start making withdrawals.

Also for Roth account owners who have paid income tax on the amount contributed, they will owe no tax on their withdrawal, as long as they meet the stipulated requirements. Else, they will be charged an extra 10% early-distribution penalty tax on any other tax they owe.

Note that both accounts are subject to required minimum distribution or RMDs. After age 70½, account owners are required to withdraw at least a specified percentage from their 401(K) plans, using IRS tables based on their life expectancy at the time of withdrawal. Nonetheless, if they are still active in service and the account is with their current employer, they may not have to take RMDs from their plan.

What to Do When Changing Jobs

Do no fret whenever you decide to leave a company, your contribution is still safe. When leaving a company where they have a 401(K) plan, there are four options available for you:

  • You can choose to withdraw your funds
  • You can it rollover into an IRA
  • You can decide to leave it with your previous employer
  • Or transfer to the new employer

In a scenario where an employee gets fired, there might be some alterations to the funds in your 401(K) plan. Note that your company cannot seize your 401(K) funds, it might necessitate you transfer it to another account. You might also be losing any contributions that the company made on your behalf.

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