A 401 K is a retirement plan offered by a company to its employees. This gives employees a convenient way to save a portion of pay for their retirement. Do you know the advantages and rules of investing in a 401K?
One of the greatest advantages is that money invested in a 401K grows tax-deferred until retirement. This allows the money invested to amass more quickly. This is because you are not having to pay out taxes each year on the earnings you make in your 401K investments.
A traditional 401K invests money before income taxes are deducted. Your tax costs are less because the amount of money put in a 401K is deducted from your total yearly income. You are investing money before paying taxes on it.
A Roth 401K invests after taxes are paid on income. So why go with a Roth version? A Roth 401K does not charge taxes when you withdraw your money in retirement. A traditional 401K does charge taxes because the initial deposits were deposited before taxes were incurred. Your earnings are taxed when you withdraw money from a traditional 401K. Earnings are not taxed when withdrawn from a Roth 401K provided you meet the withdrawal eligibility requirements.
Many 401K plans offer matching employer contributions. A company will match what you put in, up to a certain percentage. Companies are not required to do this, but most offer a match. The percentage of the match varies by company. This match is a great benefit to you. It is like getting free money.
Any contributions you make are fully yours from the time of contribution. However, many companies require you to work a required amount of time before you can have full ownership of the matching contribution. This is called "vesting". You have full ownership of the match once you are vested.
How much can you contribute? This is determined by the IRS. The IRS sets limits on the amount of contributions allowed from year to year. Your employer can tell you the maximum you can contribute. There is an additional catch-up amount you can contribute if you are over fifty.
A Roth 401K allows withdrawals free of charge after five years. You have to wait to age 59 1/2 to start making withdrawals from a traditional 401K. Prior to this you will pay a penalty. A few exceptions apply. You may take withdrawals after age 55 if you have retired from your company. You may also take withdrawals if you suffer a disability. Your beneficiary can take withdrawals if you die.
You may have access to funds prior to 59 1/2 if you have a hardship. This may be for medical care or the purchase of a home. You must really have a hardship to do this. It is best to avoid this if possible. Early withdrawals are subject to taxes and penalties. This greatly affects your retirement.
You may also be able to take a loan from your 401K. A loan is subject to interest. It must be repaid to the plan. A loan will not be taxed if it meets IRS criteria.
You must begin taking required minimum distributions from a traditional 401K when you reach age 70 1/2. A huge penalty is incurred if you don't start the withdrawals. A Roth 401K is not subject to required minimum distributions.
You can rollover your 401K if you leave your company. You can roll it over into your new company's plan or into an IRA. Some companies will even let you keep it in the old plan. Either way, do not take it out as a lump sum. This money needs to stay in a plan for your retirement.
Within a 401k you will have various investment choices in which to invest. This includes stock and bond funds. Each plan is different and varies based on who is administering the plan. Usually the company chooses a plan administrator that is a mutual fund company. Your company or administrator will give you information on your investment options. You can then choose what you want to invest in for your retirement.
Definitely take advantage of a 401K if your company offers it. At least put in enough to get the match. Again, this is like getting free money. Besides, if you put in $1000 and the company matches that $1000, you have just doubled your money. This is a good deal in any economy.
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