Examining your 401(k) plan! (Part 2 of a 3-part series)

Have you read your employment contract fully? Once you’ve started a new job, most large companies include as part of the terms of your employment contract a 401(k) plan, usually allowing you to start contributions a specified period of time after you begin working. So what is a 401(k) plan? In layman’s terms, it is an easy way to save for retirement. A 401(k) plan is: “A qualified plan established by employers to which eligible employees may make salary-deferral (salary-reduction) contributions on a post- and/or pre-tax basis. Employers may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.” [1]
Basically, this means that any money you put into the plan is tax-deferred. For example, see the table below:





You only pay taxes when you withdraw your money. In the meantime, your principal grows tax-free! For example, let’s say you invest $1 into a mutual fund outside the 401(k) plan. First, before you even invest the $1, it is taxed by the government. So you actually start out with only 72 cents. It would need to make a 40% return to return to a dollar again, and this would take a couple years. Contrastingly, if you invested $1 into a mutual fund through your 401(k) plan, you would start off with $1. On top of that, many employers will match a potion of your contributions anywhere from 25 cents to 50 cents on the dollar. So through a 401(k) plan, automatically you’ve earned a 25%-50% return on your dollar without your investments doing anything!
Also note that you should (as I mentioned in the first blog) start early!! Below is a chart showing your savings based upon a $100 contribution monthly to a 401(k) plan with a 8% annual return.
[2]

With a 401(k) plan, note that if you withdraw any of this money before age 59 ½ there will be a penalty. There is also a limit to how much you can put in pre-tax to your plan- in 2007 it is $15,500. But should you change jobs, you can switch your old 401(k) money to your new one (or an IRA). Even though the investment options through the 401(k) plan might not be as exciting or aggressive as you’d like, most plans have a wide array of mutual funds, bond funds, and money market funds to invest in. You should always contribute as much as you can to your fund, because employer matching is an addition to your salary. If you invest all $15,500 and your company matches 50 cents to the dollar that is a $7,750 bonus! Not only that, but your investment is tax-deferred. So don’t delays in contributing to your 401(k) plan- it can add up to substantial savings for retirement!





Next week: IRA's !!!



[1] Investopedia. http://www.investopedia.com/terms/1/401kplan.asp
[2] Cost of Waiting, https://www.fiserviss.com/pls/portal/docs/PAGE/401K_MAIN/401K_ASSETSLIBRARY/money-chart.jpg