The What, Why and How of a 401(k)
The best time to plant a tree was 20 years ago. The next best time is now.
What is a 401(k)?
Simply put, a 401(k) plan is an investment account offered through an employer to help employees save for their retirement. A 401(k) typically includes a variety of investment options to choose from based on personal risk tolerance.
Why have a 401(k) Plan?
The purpose of a 401(k) plan is to help set aside money now, to cover expenses in retirement later. The average person spends close to 20 years in retirement.
How do 401(k) Plans Work?
- You determine an amount to be automatically invested in your account from each paycheck
- You choose where these contributions are invested, or use the default fund set by your company
- Over time, these investments may grow with compound interest
What Happens if I Leave the Company?
The money you contribute to a 401(k) is 100% vested (meaning owned by you). Any contributions made by your employer are subject to the vesting schedule defined by your plan.
Essentially, there are three options:
- Stay in your previous employer’s retirement plan
(depending on your vested account balance)
- Rollover the funds to your new employer’s retirement plan or an IRA
- Cash out, which can expose your savings to taxes, penalties and fees
You can start contributing to a 401(k) plan once you have met the eligibility requirements defined by your company.
After eligibility is met, you can start or stop contributing to a 401(k) at any time, as well as increase or decrease your contributions. You can choose to contribute pre-tax, which is referred to as traditional contributions, or post tax, which is referred to as Roth contributions.
Traditional contributions are deducted from your paycheck before taxes. Therefore, the money you contribute doesn’t count toward your gross income for the year, thus lowering your taxable income. Any earnings are reinvested back into your account. Both the contributions and the earnings won’t be listed as income on your tax return until you withdraw them.
Roth contributions are deducted from your paycheck after taxes. Since these contributions have been taxed up front, earnings will grow tax free. Once retirement age is reached and the money is distributed, the original amount contributed as well as any growth will not be taxed.
Start Contributing to a 401(k) Plan Today!
While the most beneficial investing strategy is usually to invest early and invest often, the most important step is to start.