The ABC’s Of Your 401k
If you feel confused about your 401(k) — what it is, why you should contribute to it, and how to invest the money in the plan — you’re not alone. Retirement plans have gotten so complex with so many choices, it’s normal to scratch your head from time to time.
So let’s start at the beginning. The name of this plan comes from the section of the tax code that covers it. Basically we’re talking about money from your salary that you “direct” into a company-sponsored 401k plan before it’s paid to you in a paycheck. Most financial advisers (including me) recommend maxing out your 401(k) contributions. This means contributing as much as your employer and the IRS allow. There are three major (and I do mean major) advantages in doing this.
First, the money that goes into your 401k is coming out of your salary before you pay taxes on it. You’ll most likely notice this when you’re doing your taxes. Think of it this way: If you’re in the 28% tax bracket and you made a contribution of $1,000 to your 401(k), it really only cost you $720.
Second, more than 85% of employers who offer 401k plans match a portion of their employees’ contribution, according to a 1998 study by William M.Mercer, a human resources consulting group. This is probably as close to a free lunch as you’ll ever get — and does it ever make a difference! Suppose again you contributed that $1,000 and your company matches 50 cents on the dollar. That’s another $500 into your plan, or an automatic 50% return on your money without even counting the return that your investments will earn. How can you beat that? You can’t.
Third, the money — your contribution and your employer’s “match” — grows tax free until you take it out. Hopefully that’s after you retire and are in a lower tax bracket. Think about other savings or investment accounts you have — each year you receive a “1099″ showing the amount of interest, dividends and capital gains you’ve made on those investments during the year. Does that go unnoticed by the IRS? No. Essentially, that’s additional taxable income to you. Now, what if there were no taxes each year on the interest, dividends or capital gains, and instead that money continued working for you. Pretty powerful growth over the long term, right?
I assume now that you are convinced about the advantages of the 401(k) and you are, or soon will be, putting in the maximum amount you can. Congratulations! But your work doesn’t stop here. Next you should check to see how financially fit your 401(k) really is.
Related Articles
- Reverse Mortgage - The Pros And Cons
Reverse mortgage is gaining popularity to seniors because it provides a solution to those who cannot keep up with the traditional mortgage. Nowadays, reverse mortgages.... - How To Budget And Save Money
We all have a variety of needs and goals in our lives and money is one of the tools we utilize to meet these. Most.... - How To Organize Your Finances
It is a waste of time, energy, paper, and usually money to have a lot of credit cards, bank accounts, brokerage accounts, or insurance policies..... - Credit Cards For Teenagers And Students
Should your teen carry a credit card? There’s no one right answer. Most kids learn their money management skills from their parents. So, before deciding.... - How To Preparing A Will
Nowadays, accident happens everywhere you turn. When the time comes you are ready to leave your loved ones behind, remember that memories are not the....
