Have you thought about your future? Chances are if you’ve found this article, you have realized you can’t work forever. That doesn’t really leave much time to enjoy life, take vacations, or start knocking down your bucket list.
So, you may have just started learning about retirement plans. Or, you’ve just said your goodbyes to procrastination-land. Either way, it’s a great day to start taking on fiscal responsibility. Eventually, you will leave behind the corporate gladiator pits to enjoy a well-earned retirement. When you do, you don’t want money to be a problem, do you? You owe it to yourself to secure your financial future before retiring. There’s no better way to do this than enrolling in a 401(k) plan.
Is A 401(k) Plan Safe?
Now that you’re prepared to take on this overwhelming process, questions and concerns will surface. For instance, you’re thinking, “Is the 401(k) a safe investment? What if I make the wrong move with my money?” Well, we’re here to tell you investing in a 401(k) plan is easier and safer than you think.
Today, there’s tons of money invested in the 401(k) plan. This is the first thing you should know in this Beginners Guide to 401(k). For this reason, stringent laws and strict regulations heavily protect these funds. To learn more about the safety and protections you can investigate ERISA’s Protections.
Money Is Already Tight
When you think about it, how much of the money you earn is really yours? If you’ve experienced having too many days left in the month and not enough money left from your paychecks, you know exactly what we’re talking about. You’re earning money, but you have all sorts of expenditures. Not to mention the taxes you pay! After all the money you earn leaves your pocket dollar by dollar, what’s left for you?
Moving from paycheck to paycheck without a financial plan in place has serious repercussions. The most severe one is living only on social security once you retire. If you’re thinking, “But won’t saving for retirement leave even less money in hand? Is that such a good idea?” you’ve lost sight of the end game. A habit of saving will enhance your lifestyle, not diminish it. So, if you’re ready to save money and cut your taxes, this Guide to 401(k) will show you how.
401(k) Plan: The Basics
At its core, the 401(k) is an account similar to a savings account. A 401(k) plan allows you to build a fund you can tap once you retire. While you work, you move a part of your income into your 401(k) account. As your career progresses, the 401(k) account grows. Finally, when you retire, you can withdraw the money in your 401(k) account to support you during retirement. That’s all there is to it. Well, the simplified version anyway. In a way, a 401(k) is a savings plan on steroids!
How A 401(k) Account Works
When you’re enrolled in a 401(k) plan, a part of your income goes into your 401(k) account. You are free to decide the amount you want to contribute to your 401(k) plan. Once you do, your company’s payroll department deducts your 401(k) contribution from your paycheck.
Usually, it can take a few days or weeks for the withheld contribution to reach your 401(k) account. But, don’t worry, this delay is due to administrative limitations. Your company isn’t trying to scam your 401(k) money. There are regulations that prevents them from doing so.
Benefits of Joining A 401(k) Plan
The biggest advantage of signing up for a 401(k) plan is tax deferment. What this means is you don’t have to pay income tax for the money you deposit into your 401(k) account. You only have to pay tax when you withdraw it. This is awesome because your post-retirement income will be less than what you earned before retiring. Naturally, the tax payable also decreases proportionally. Another huge advantage is the system forces you to save. Since your contribution reaches your 401(k) account directly, you can’t skip payment or procrastinate.
401(k) Account vs Savings Account
In a traditional savings account, you don’t have a say in how you want to grow your money. The bankers decide how to invest your money. But, when you open a 401(k) account, you can choose where to invest your money. You can pick safe options that provide a small steady return. Alternatively, you can invest in more volatile and risky options, such as stocks or real estate. Even options that lie in between safe and risky are available.
Choosing 401(k) Investment Options
If you are more than 25 years away from your retirement age, go for options that provide higher returns. As you get closer to your retirement age, move your investment to safer options. You can do this by selecting a target retirement fund as your investment option.
How Targets Work
A target retirement fund is a mix of many types of investments, such as stocks, bonds, real estate, and cash. When you’re farther away from your retirement age, this fund contains mostly stocks. As you approach the target retirement date, the fund automatically shifts your investments to safer options. Learn more about target retirement funds here.
Roth 401(k) vs Normal 401(k)
Choosing the Roth 401(k) means forgoing the tax deferment benefit. The money you put in a Roth 401(k) account is taxable. However, when you withdraw the money, it’s tax-free. If you’re just starting your career and not paying a sizable income tax currently, a Roth 401(k) account is your best bet. But, if you’re mid-way through your career, a normal 401(k) account is the way to go.
401(k) Matching Funds
The 401(k) plan allows your employers to match your contribution to your account. For instance, if you contribute $4,000 to your 401(k) account, your employer adds another $4,000 to it. This doubles the amount going into your 401(k) account. Not all employers offer this provision. But, if your company does, you must join the plan as soon as possible. Otherwise, you’re just leaving money on the table.
No 401(k)? No Problem
You can avail the tax deferment benefits of a 401(k) plan by opening an individual retirement account, or IRA. To do this, contact a brokerage firm and setup a tax-deferred account. Then, arrange for an auto-deduction from your checking account so that your contribution goes automatically into your IRA account. At the same time, seek employment in a firm that offers a 401(k) plan. When you find one, the best part is you can maintain both an IRA account and a 401(k) account.
401(k) Plan and Quitting A Job
If you change jobs, there are three ways to handle your 401(k) account. You can move the money in your 401(k) account into your new employer’s plan. You could also transfer the money into an IRA rollover account with the help of a brokerage firm. In extreme cases, you can cash out your 401(k) account and take the money. But, this is not a smart move.
Cashing Out 401(k) Account
You can cash out your 401(k) account any time you want. But, you should do so only in cases of extreme emergency. There is a 10 percent penalty on premature withdrawal of funds. More importantly, by breaking your 401(k) account, you are undoing years of systematic saving efforts. So, you’re better off seeing your 401(k) account as untouchable until you retire.
The Best Time to Start Is Now
Don’t be too hard on yourself if you haven’t been able to save any money so far. You can change that right now. Starting today, contribute at least 10 percent of your income to a 401(k) account. Think about this: how much will a 10 percent decrease in your take-home salary affect your life? Not much. But, it can make a huge difference to your life in the long run. So, for a happy retired life, free from financial woes, join a 401(k) account immediately.