Saturday, June 2, 2018

How Does a 401k Plan Work

For many Americans, their 401k is simply another expense taken out of their paycheck. They may vaguely know that it involves saving for retirement, but not many people take full advantage of their 401k’s,or know just how much having one can save them in the long run. The time to start thinking about retirement is “as soon as possible”, and a 401k can help make that saving easier and more lucrative than proverbially stuffing bills under the mattress, especially as more and more Americans are finding themselves dangerously underprepared for retirement.


So what exactly is a 401k? Put simply, it’s a retirement savings account provided by your employer. 401k plans function similarly to pensions accounts, though pension accounts are now primarily used for government workers, as the costs to employers became too high for many in the private sector. The money diverted to your 401k is tax-free until it comes time to withdraw, ensuring more ability to save, and there are certain tax breaks and incentives available when investing in a 401k.

How does a 401k plan work?You control how the money in your 401k is invested. Many employers work with investment firms who offer an array of stocks, bonds and trusts that you can invest your money in to ensure the highest yields when it comes time to withdraw, and can assist you with any questions you have about the performance of your 401k and smart investments to make. Your employer may also offer a match to your investment, which could be dollar for dollar or a percentage of your annual salary, up to a certain limit, which varies according to companies.

There are some limits to using a 401k. Many employers have a time limit for how long you have to work for the company before you have access to your 401k savings, and there can be steep penalties for trying to withdraw money before the standard retirement age. These restrictions are put in place to incentivize people to stay with the company longer, and continue to grow their retirement plans. There is also a limit to how much you can put in per year. Typically, $18,000 annually is the maximum contribution amount, and it increases to $24,000 after the age of 50. Since 401k’s can be used for tax breaks, this helps ensure that people do not take too much advantage from these tax incentives.

If you switch employers, the 401k you have set up with your former company will remain safe, and you have several option about how to handle it. You can have your funds rolled over to an account with your new employer, if applicable. You can leave your funds with your previous employer, and access those funds when you’re ready to retire. While you won’t be able to make any changes to your plan, the money will be safe and waiting for you. You als have the option to cash out your 401k, but you will have to deal with any fees and fines that comes with cashing out before retirement age.

With all this information, your next question may be “How much exactly should I put into my 401k?” That is completely dependent on your current financial situation. At minimum, contribute the max amount that will allow your employer to match your 401k. From there, consider your regular expenses and debts. Try to pay off any high interest debts before divesting those funds to your 401k, as it will save you more money in the long run.

While retirement may seem like a lifetime away, the steps you take today to ensure you have the most money available will help make sure your golden years are restful. Opening a 401k account today is the first step to a peaceful retirement.

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