What is a 401k plan
What is a 401k plan: Essentially, a 401 (k) is an investment tool for retirement. It is a type of plan called “defined contribution plan”.
You put the money in an account that then invest in stocks, bonds, money market accounts and more. You work with a company such as Fidelity Investments or Vanguard, to select the investment mix. This amount of money grows over time, and usually offers better performance than a traditional savings account. Once you retire you, you can start withdrawing funds from 401 (k) plan for your support.
What makes it special?
(K) plans are offered 401, or “sponsored” by employers. You can not go you and just open one.
Money invested in a 401 (k) is deducted from your paycheck before taxes. However, taxes will be applied when you withdraw the money during retirement. The idea is that your tax rate during retirement is lower than your current tax rate.
Employers often make a contribution equivalent to a certain percentage of the amount you put into the plan (which is also called “elective deferral”). Say destine 4% of your salary to your 401 (k). Your employer may provide additional money to this account for retirement. It could be a 1% 2% 3% more. However, employers are not required to make this contribution, so the amount will vary greatly. People often call this “free money”.
What’s the trick?
Not too many, but there are some additional issues that you should know.
From 2014, the most you can defer to your 401 (k) is $ 17,500 per year, unless you have 50 years or more. In that case, you can defer up to $ 23.000.
If you take money from the account before having 59.5 and a half years, usually you will incur a penalty of 10% in addition to regular income taxes that you must pay. So a 401 (k) should definitely be considered a strategy of long-term savings.
Growth will depend largely on the market. Over time, the stock market shows a very consistent growth, so it’s not a risky strategy. However, there is no guaranteed performance. Your savings could grow by 2% or 12% in a given year. Just remember that, in general, over time, these retirement accounts offer better returns than a savings account.
My employer does not offer a 401 (k).
There are many other defined contribution plans similar to 401 (k).
Employees of tax exempt institutions may be able to participate in a 403 (b). Government employees may have a 457 plan, and civilian employees of the federal government could have a Thrift Savings Plan Savings. Your employer may offer a Roth 401 (k), which is similar. The key difference is that with a Roth 401 (k) plan the income tax is paid at the time of investment, or when the funds are withdrawn during retirement. The taxability of any distribution will depend on whether “eligible” or not. In most cases, a participant must wait until we have at least 59½ years old to receive a distribution from a Roth 401 (k) plan that meets the requirements.
If your employer does not offer any of these plans, or if you are self-employed, you can open an individual retirement account (Individual Retirement Account, IRA), MYRA, Roth IRA or SEP IRA.
What is a 401k plan