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Introduction
401(k) Defined
401(k) Advantages
The Drawbacks
Investment Basics |
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401(k)
Defined
401(k) plans are retirement vehicles that allow employees to save for their own
retirement. This type of plan was named for section 401(k) of the Internal Revenue Code,
which permits employees of qualifying companies to set aside tax-deferred funds. We at
401k Forum are proud to have the person who first developed the 401(k) plan, Ted Benna, as
a member of our Board of Directors. By making this change to the Code in 1978, the
government opened the door for more efficient retirement planning for all Americans. It's
no exaggeration to say the 401(k) plan is the most important national retirement effort
since Social Security was introduced in the 1930s. |
How It Works
The 401(k) mechanism is fairly simple. The
plan is set up by your employer as a defined contribution retirement arrangement.
That means you are the one who pays into the plan, although your employer and the plan
provider who offers your 401(k) do just about all the work.
Your 401(k) contribution is automatically
deducted from your paycheck each pay period. This money is taken out and invested before
your paycheck is taxed. After you have decided what percentage you want deducted from your
check, and how you want to invest it, your work is pretty much done.
Once the money is deducted from your
paycheck, you can't spend it, but it is yours. It grows in your personal 401(k)
account. Although you can withdraw the money for certain emergencies or in some cases
borrow against your investment, the money is intended to stay in your account until you
are at least 59 1/2.
While the investment is growing in your
401(k) account, you do not pay any taxes on it. When you withdraw the money at retirement,
you pay taxes on the amount you withdraw from your account (so you pay taxes little by
little instead of being hit with one big bill).
Employer Match
In some cases, employers make their own
contributions to your 401(k) plan. This contribution takes the form of an employer match
on your contribution. Usually the employer matches a certain percentage of your
contribution. For example, an employer may elect to put in 50 cents for every dollar you
contribute. That's an immediate return on your contribution, regardless of how you invest
your 401(k) money.
Not every employer matches the employee
contribution, but in some cases the company will match the employee contribution
dollar-for-dollar.
What Do You Have To Do?
A 401(k) plan is an investment vehicle.
Within the particular plan offered by your employer there are a number of investment
options (each plan has a different set of options). These options may include mutual
funds, guaranteed investment contracts (GICs) and, in some cases, stock in your employer.
You decide which of these investments you want to buy, and how much of your total
contribution you want to put in each.
This is a key difference between paying
into Social Security and contributing to a 401(k). With Social Security, Uncle Sam decides
how to invest your money. With a 401(k) plan, you decide for yourself. That may seem
scary, but it gives you the opportunity to invest in a range of high-quality,
professionally managed and potentially very lucrative investments. The Social Security
Administration, on the other hand is legally obligated to stick to a very narrow range of
investments.
How Do You Know Your
Money Is Safe In Someone Else's Hands?
It is very easy to keep track of the
savings in your 401(k) account. At regular intervals, you will receive an update telling
you how your investments performed. Most plans also provide toll-free numbers and web
sites you can access to keep track of your 401(k) holdings. You can move the money around
within your plan easily.
A 401(k) is the easiest savings plan
available to most American workers. It makes investing convenient and simple, and
encourages you to save for the long term.
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