Understanding 401(k) Plans: Preparing for the Future
Do you have money in savings? If you’re like many Americans, you might not. Research has shown that 38% of Americans would struggle to make an unexpected $500 payment, while 25% have no form of emergency savings at all.
The present economic climate makes it difficult to get by in the present. Preparing for the future is something that many people can’t afford.
401(k) retirement plans are something that many employers offer to their workers. These plans can yield you sizeable chunks of savings, helping ensure that you’re set for success after retirement.
But what exactly is a 401(k)?
Keep reading to learn all about 401(k) retirement plans and why having one is a smart idea.
What Is a 401(k)?
A 401(k) is a type of account that grows from pre-tax money. The money inside a 401(k) account gets distributed into different areas where it can further grow. Most of the time, it gets put in places like stocks, mutual funds, and bonds.
As mentioned, many employers provide their workers with 401(k)s as a form of benefit. It benefits the worker as they get money for later on in life, and the company, as the employees might not want to give that benefit up.
Congress first created the 401(k) in 1981.
How Taxes Work
One of the best parts about having a 401(k) is that you can save money on taxes. That’s because paying into the plan allows you to benefit from pre-tax payroll deductions.
The IRS considers the money that you put into your 401(k) to be a deferral. That means that you don’t have to pay taxes on it until you use it. This can cut down the amount of money you need to spend on income taxes.
For example, if you make $50,000 and choose to put 5% of your annual salary into a 401(k), your salary that you report to the IRS will only be $47,500. This will save you hundreds of dollars in taxes each year.
Employer Contributions
Many employers don’t just provide you the option of paying into a 401(k) plan. They also support that fund and take action to help it grow larger.
Understand that any money that your employee contributes towards your 401(k) is pre-tax. When you withdraw it after retirement, you’ll need to pay taxes on it.
Let’s take a look at a few of the ways that your employer can support your 401(k).
Matching
One common form of support that many employers offer is 401(k) matching. That means that for every dollar you put in, they’ll match that amount.
Some employers provide dollar-to-dollar matching, while others only offer it to a certain amount. For example, they may offer to fully match the first 3% of your salary that you put towards your retirement and then offer partial support from that point on.
Make sure to contribute the necessary amount of money to take advantage of your employer’s support!
Non-Elective
In a non-elective program, your employer decides to take a portion of your salary and put it into a 401(k) regardless of whether you contribute to it.
For example, this might mean that they take 3% of your salary and that of your coworkers. You can choose to supplement that money with your own investments.
Profit-Sharing
In a profit-sharing model, your employer contributes to your plan when the company makes money. Depending on the profit made, this can either be a small or large amount of money.
Companies use different formulas to dictate how much money employees receive. Make sure that you understand these formulas and that you know how much profit you’ll net when the company does well.
Understand the Different Investment Choices
As you might expect, different people prefer different investment strategies. You might want something more aggressive, but your coworkers might be comfortable investing more modest amounts.
To accommodate the preferences of different people, most 401(k) plans come with several different investment options. These also come with different levels of risk. It’s worth meeting with a financial advisor beforehand who can help you analyze the different options.
Many 401(k) plans come with a target-date option. That allows you to select the year you think you’ll retire. For most beginners or non-financial experts, going with this sort of a general option will be the best choice.
Just make sure that you understand all of the important information!
When Do You Get the Money?
Some people might be wondering when they can actually access the money in their 401(k). The answer to that is: it depends.
Different plans allow you to access your money at different times. For example, some plans allow you to take it out without incurring penalities at 55. In other cases, you may have to wait a bit longer to get it.
All plans allow you to access the money that you contributed, but you might not be able to get the money that your employer put in if you take it out early. Other times, you’ll only get to take a portion of it.
Make Preparing for the Future a Priority Today
While paying for the present can be hard enough, it’s always a good idea to start preparing for the future. One of the easiest ways to do that is by investing in a 401(k).
Refer to this guide to help you better understand 401(k) retirement plans and how they work. Remember—the more you can invest now, the better off you’ll be later on!
Are you looking to learn more about different investment choices and plans? If you are, spend some time checking out the other posts on our site. You’ll find plenty of other finance-related guides, tips, and explanations.
June Potter wrote this article on behalf of FreeUp. FreeUp is the fastest-growing freelance marketplace in the US. FreeUp only accepts the top 1% of freelance applicants. Click here to get access to the top freelancers in the world.
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