Thinking 401(k)? Here’s an Overview
A 401(k) plan is unquestionably one of the best ways to save for your retirement. So, if your employer offers one, take advantage of it and begin contributing as soon as possible. If you’re lucky, your employer will also contribute additional money to your plan each time you make a contribution.
This type of deferred compensation retirement savings plan for the benefit of most private firms’ employees was authorized in 1978. Employees who participate:
- Defer part of their salaries
- Determine how much of their salary they defer
- Determine how to invest the money
Yes, the paycheck you take home will be smaller, but there are several major advantages to saving for retirement through a 401(k):
- Immediate tax savings on contributions – You only pay taxes on that smaller paycheck amount you are taking home, not your investment.
- Taxes on any investment earnings are deferred, and the same holds true for earnings made on your investments.
- In-service loans and withdrawals – You are able to borrow from your deferred funds, but do so only as a last resort as the fees and penalties you will accrue are incredibly steep should you not repay that loan before you retire or change jobs.
- Free money – Employers may choose to match a portion of the money deferred by their employees. Whatever the amount your employer is willing to match, make sure you contribute at least that much to your 401(k), so you take full advantage of all the free money your employer is willing to give you.
- Diversification – Since employees can choose how to invest their 401(k) funds, if you are ten years or more away from retirement you need to consider putting all of the money that you defer into an equity index fund. Be sure to check with your financial consultant to determine if that is right for you.
Investment choices in a 401(k) plan are likely to be:
- Money Market funds
- Stable value accounts such as GICs (guaranteed investment contracts) or bank deposit accounts
- Bond mutual funds
- Stock mutual funds
Rule of thumb: the higher the investment risk, the higher the reward potential. Conversely, the lower the risk on an investment, the lower the reward potential will be.
As with any investment, since everyone’s personal situation is unique, you are strongly urged to consult with a qualified financial professional in order to make the most of your 401(k) investment.
Please Note: This information contained herein not intended as financial advice. It is for educational purposes only.