What exactly is a 401(k) plan?
- A defined-contribution employee benefits plan offered by many employers
- “Defined contribution” means that employees contribute their own money to the plan, normally through payroll deduction
Benefits of a 401(k)
For the employer
- It attracts and retains employees
- Helps their employees plan for retirement
- Gives their employees a choice in their financial future
- Tax benefits
For the employee
- Simplifies investment decisions
- Immediate investment return
- Withheld from your paycheck so you never see it or have a chance to spend it
- Both you and your spouse can each have a 401(k) account
- Tax-deferred- you do not pay income taxes on the money when you contribute it but instead you pay taxes when you withdraw it at retirement
- Since you don’t pay taxes on the money when it is withheld, it lowers your net income tax bill
- The money in you 401(k) account can be invested in a number of mutual finds- helping the money grow faster
- The interest you earn on the money is also tax-deferred until you withdraw it
A 401(k) plan makes it possible to have more money in your paycheck. This is because with 401(k)s you can increase your take-home pay and decrease your current taxable income.
ABCs of 401(k) plans
- Automatic payroll deductions
- Brokers or portfolio managers manage your account rather than your employer
- Contribution can be accessed in case of emergencies (loans and withdrawals)
Withdrawing your 401(k) money
- At age 70 1/2 you can withdraw all or part
- Income tax costs begin with withdrawal
- A penalty for early withdrawal prior to age 59 1/2
- Most plans let you borrow money from your 401(k) plan- you must repay to avoid penalties
