Benefits of 401k Plans
All you need to know about 401k plans is that they provide the best way to allocate money for your retirement. Additionally, many employers are ready to give you money as long as you participate in the company's retirement plan. Another important point you should keep in mind is that the sooner you start the better. The equity index fund is most appropriate for those of you who have more than 10 years from retirement.
Knowing the basics about 401k plans is of extreme importance regarding your financial future during your retirement years. We have tried to collect all the information that represents a "must know" and present it to you in the most understandable way even for those of you who have no economics education whatsoever.
The Internal Revenue Code (the IRC) authorized a new way in which employees can defer money for their retirement accounts. This happened in 1978 and the employees who participated in the company-sponsored 401k plans were allowed to contribute a percentage determined by themselves to their 401k accounts and also establish how the contributed money will be invested.
Benefits of 401ks
What makes employees deprive themselves of a certain amount of money for the sake of a retirement account contribution? First of all you immediately save taxes on the contributions. Saving for retirement through the use of a 401k plan also provides you with in-service loans and withdrawals. The earnings you make on your investment are tax-deferred. Finally, investing for your retirement provides you with some money for free.
Let us take a closer look on the benefits of 401k plans and make a short analysis of each.
- Contribution tax savings
Since contributions are made before you are being charged a tax on your income, you pay significantly lower amounts to Uncle Sam. The contributions you decide to deduct from your monthly paycheck go directly into your retirement account. There, they are safe from the federal and state taxes. Only after you retire you will be liable to taxes which will be of far lower amount than you will pay today.
- Tax-deferred investment earnings
The earnings you get from the allocated contributions are exempt from taxes. This means that throughout the years until you retire, every return on your retirement investment will not be subject to taxation.
- In-service loans and withdrawals
The good thing about 401k plans is that some of them allow you to borrow the money you have accumulated into your account. This means that you lend money to yourself! Whenever you need money to buy a house or a car, think over the alternative of borrowing money from your 401k plan.
Borrowing money from your 401k plan is not recommended if you plan to change your job. In such a case you will be required to give the money back in full. Failure to do so may result in taxation. Additionally, you will be subject to penalties of 10% if you are younger than 59 ½. In case you decide withdraw your money earlier you will be subject to the same events.
What is more, the interest on the loan we pay represents money that has been already taxed. However, these earnings will be taken as untaxed and once you reach retirement you will have to pay taxes on them again when you start to make withdrawals.
- Employer contribution matching
The last benefits of 401k plans come from the fact that many employers provide their employees with contribution matching. This means that you get some free money since your employer matches a certain portion of your monthly contributions. If your employer provides this opportunity, don't hesitate and grab it. You should commit yourself to reaching the limits up to which your employer will match your contributions in order to get the most out of it. If your employer makes a dollar-to-dollar matching you will be a complete fool not to seize the opportunity. This matching means that your boss doubles the amount of your contributions by giving a dollar for every dollar you have allocated.
You should make sure that you start allocating money to your 401k plan as early as possible and do it regularly. Make sure that you select the right investment opportunities for you, which both meet your current financial situation and correspond to your financial goals. Only then you will be able to benefit from the many benefits of 401k plans such as compounding just to name a few.
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