401k Retirement Plan: Learn the Basics

A 401k retirement plan has a lot of advantages, but is a 401k right for you? Read on to learn the basics of this retirement plan:

What is a 401k?

A 401k is a retirement plan sponsored by the company that you work for. It allows you to authorize your employer to take pre-tax dollars from your paycheck, and to invest them in funds that you have chosen from the investment funds offered in your company’s plan.

How does a 401k work?

When you set up a 401k, you decide how much money you want to invest towards your retirement, and this money is taken out of your weekly paychecks. You can choose a certain percentage of your income that you would like to invest, or you can choose a specific dollar amount. Either way, this money will be removed from your paycheck before taxes are calculated on your earnings—thereby decreasing your tax liability and increasing the amount of money that you have to invest.

Some employers will match your contributions up to a certain percentage, giving your own personal investments more power.

When can I access a 401k?

You may withdraw funds from your 401k when you reach the age of 59 and ½. At this time, you will pay income tax on all of the money that you take out.

Should you need to access the funds prior to reaching the age of 59 and ½, you may do so; however you will suffer stiff penalties for early withdraw.

You may also borrow money from your 401k at any time; however this can be quite costly, as you will have to pay back the money with after-tax dollars and add on the cost of interest.

Before borrowing any money from a 401k, bear in mind that your loan will have to be paid in full immediately if you decide to leave your job or are fired. Failing to do so will result in steep penalties and could put your 401k at risk.

What happens to my 401k if I switch employers?

If you decide to leave your current job, you may leave your 401k in your current employer's plan, roll it over to your new employer's plan, roll it over to an IRA or cash out the account and paying the associated taxes and penalties.

What are the benefits of a 401k?

There are many benefits to the 401k plan. These include:

• The opportunity to invest pre-tax dollars.
   
• The opportunity to lower your taxable income.
   
• Employer contribution matching for participating companies.
   
• Low cost retirement investing, if no-load.
   
• Automatic retirement investing—just authorize your employer to take the money from your paycheck, and the work is done.

What are the disadvantages of a 401k?

• You can’t withdraw the money until age 59 and ½ without suffering a penalty.
   
• You have to choose your investments from funds held within your company plan.
   
• Yearly contributions are capped by the government.
   
• High cost retirement investing, if your plan carries a load.

401k and You

A 401k can be a great retirement investment vehicle, but only if it feels right for you. Weigh the advantages and disadvantages of your company’s 401k plan, and decide if participation is appropriate for you and your retirement goals.

~ Erin Huffstetler, Staff Editor

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