Retirement is our topic of the day today, so we thought we’d dive into one of the most common retirement accounts available. A 401(k) is a type of retirement savings plan offered by many employers to help their employees save for retirement. It's named after a section of the U.S. Internal Revenue Code. This plan allows employees to contribute a portion of their pre-tax salary into a designated investment account. The contributions are automatically deducted from the employee's paycheck before income taxes are applied, which can provide potential tax benefits by reducing your taxable income for the current year.
Key Points to Understand about 401(k) Plans
Employee Contributions
You can contribute a percentage of your salary or a fixed dollar amount to your 401(k) account. Many employers also offer a matching contribution, where they contribute a certain amount for each dollar you contribute, up to a specified limit. This is essentially "free money" and a great way to boost your retirement savings.
Many organizations offer 401(k) matching as an additional workplace benefit. According to the Society for Human Resource Management, “Advisory firm XpertHR's 2021 Employee Benefits Survey found that among the 271 surveyed employers that offered a traditional 401(k) plan, 82 percent matched at least some portion of employee contributions to the plan, compared with 18 percent that provide no matching funds.”
Tax Benefits
The contributions you make to a traditional 401(k) are not taxed when they're made, which can lower your current taxable income. However, you'll eventually pay taxes on the money when you withdraw it in retirement.
Investment Options
Within your 401(k) account, you'll typically have a range of investment options to choose from, such as stocks, bonds, mutual funds, and more. The specific options depend on your employer's plan.
Tax-Deferred Growth
One of the major benefits of a 401(k) is that any investment gains within the account are not taxed as long as they stay within the account. This allows your investments to potentially grow faster compared to a taxable account where you'd pay taxes on gains annually.
Withdrawal Rules
While contributions are pre-tax, withdrawals from a traditional 401(k) in retirement are subject to income tax. There are also penalties for withdrawing money before reaching the age of 59½, with some exceptions like certain hardships or early retirement.
Rollovers
If you leave your job, you can usually roll over your 401(k) funds into an individual retirement account (IRA) or into your new employer's 401(k) plan.
Vesting
While you're always 100% vested in your own contributions, there might be a vesting schedule for employer contributions. This means that you might need to work for a certain number of years before you're entitled to the full amount of employer contributions.
Final Thoughts
Remember that while 401(k) plans offer valuable advantages for retirement savings, it's important to be aware of the plan's terms, investment options, fees, and any potential limitations. It's often a good idea to consult with a financial advisor to tailor your retirement strategy to your individual circumstances and goals.
*Not financial/legal advice
*All figures are for illustrative purposes only; actual figures may vary
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