401K
A 401(k) plan is a retirement plan that is funded with
your before-tax salary contributions and often with a
matching contribution from your employer.
Here’s how the tax benefit portion of this savings plan works. Let’s say you have a job making $40,000 a year, and you elect to put $5,000 into your 401(k) plan. Only $35,000 would be recognized on that year’s income tax return. You would not have to pay taxes on the $5,000 that you invested into your retirement account. And if your employer has a matching program in which they contribute money into your 401(k) as part of your benefits package, you are not taxed on that money either.
So, you save on your taxes AND you get free money from your employer. Sounds like a no-brainer, right? You might be surprised by how many people choose not to participate in their company’s 401(k) plan despite the obvious advantages. In fact in a 2007 Personal Finance Poll conducted by Harris Interactive, only 40% of employed adults ages 18-34 who responded said that they participate in their company’s retirement or 401K plan.
For those who do chose to contribute to a 401(k) plan, the IRS determines a maximum amount that can be contributed from your pre-tax salary. For 2007 and 2008, that maximum is $15,500 a year for those under the age of 50. For those older than 50, the maximum allowed is $20,500. In 2008, the IRS is scheduled to review these maximums in light of cost of living increases and the amount may change. To learn what the current amounts are, visit www.irs.gov.
Once you put the money into your 401(k) account, leave it there. Withdrawing money from the account can significantly affect the value of your investment. As stated earlier, the employee contributions, employer contributions and any growth in the 401(k) are all tax-deferred until withdrawn. Once there is money in your 401(k), you usually can’t make any withdrawals before age 59, unless you have a special circumstance. If you do make an early withdrawal from your account, you will be hit with a penalty, generally 10%, for doing so. In addition, you will lose the value of that money over time. See The Importance of Time to learn more about how your investment can grow over time if it is untapped.
As part of managing your 401(k) plan, you will typically be given several different investment options, including money market funds, bonds and stocks. You have the opportunity to decide how to divide your money among the available options. The choices you make could have a huge impact on the value of your 401(k), so you should do some research before you invest.
One final thought on 401(k) plans. Don’t fail to invest in your retirement just because you don’t plan to be in a particular job that long. Many employees today migrate from job to job pretty quickly every few years or so. If you wait to start investing for your retirement until you’ve found THE job, you may discover that it’s too late, and you can’t get caught up. So start participating in your 401(k) as soon as you are eligible. When you leave a job, you can generally roll (or move) your 401(k) into your new employer’s plan or into a different rollover IRA. Either way, you are still reaping all the benefits that a 401(k) has to offer.
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