Understanding the benefits of 401k plans
The benefits of 401k plans are not always clear to the first time savers. Even so, no matter your age, the importance of saving for retirement cannot be understated.
Whether you plan to retire when your 65, 70, or older, you need to set enough money set aside.
That's where a 401k can help. But just what exactly are the benefits of 401k plans?
By asking this question, you're most definitely asking the right question. Understanding how a 401k works and, what it can do for you, will ultimately equal a comfortable retirement.
So let's start with the basics. Think of this post as your guide to the perks of 401ks.
What is a 401k?
In it's most basic sense a 401k is just an employer-sponsored retirement plan.
Sounds intriguing, right?
But what does that actually mean?
Well, the bare bones of a 401k plan looks something like this:
Your employer provides the plan, which you can either enroll into or (in some cases) are automatically enrolled into.
From each paycheck, a portion of your money is taken out and invested in the account. This money is taken before taxes. Taxes only apply to your 401k upon destribution.
You employer then contributes match either dollar for dollar or a certain percentage.
You make $50,000 a year. Each year you contribute 5 percent--$2,500-- from your salary to the plan.
Your employer will then either match that amount, adding an additional $2,500 to your account, contribute $1,250, or a smaller sum.
Any way the scenario works out, this is extra money that is set aside for when you retire.
In cases of "matching" contributions, it makes sense to contribute as much as you can to this account.
However there's one very important issue to keep in mind:
The IRS puts a limit on the amount of money you can contribute to 401k plans in one year. For 2015, 2016 and 2017, this limit has been $18,000.
Types of 401k plans
One of the most surprising benefits of 401k accounts: there is a variety of them.
Here's a brief overview of some of the main kinds of 401k plans available today.
Most employers will contribute to your 401k, but the they don't have to.
Employers can change how much they contribute depending on the financial health of their business.
This plan is for employers with no more than 100 employees.
The employer must make a 3% matching contribution or a non-elective 2% contribution to each eligible employee.
Contributions made to this plan by your employer are non-forfeitable.
This means that contributions made by your employer cannot be withdrawn even after you've left the company.
With a Self-directed plan you have more options on how your money is invested.
Essentially, you have a bigger discretion in selecting what stocks, bonds and mutual funds to invest in.
Another thing you don't want to overlook is a Roth 401k which also has it's perks.
Roth 401k plans are funded with after tax dollars. This can be a nice benefit since you won't have to pay taxes upon withdrawing the money.
How do 401k accounts differ from other retirement funds?
401k plans are the most popular kind of retirement plans provided employers.
While other traditional retirement programs require you to monitor and work with a fund manager, 401k plans require less work since they are managed by your employer.
Additionally, you get the added advantage of an extra contribution to your account. In many cases, this can help you save double the amount of the money.
The perks of having a 401k account at any age
Whether you're nearing the age of retirement or starting your first job, the importance of saving cannot be overstated.
There are a lot of bonuses to saving for retirement via a 401k no matter your age.
The most significant advantages include:
- More control over other investments. Most plans offer about 25-30 investment options to select from.
- Added contribution flexibility allows participants 50 years of age or older to contribute an additional $6,000 per year according to the IRS (2017).
- In many cases, 401k plans feature automatic enrollment (unless you opt out).
- You don't pay taxes until you withdraw (unless you have Roth account). When you retire, you're automatically placed in a lower tax bracket. Thus, you pay fewer taxes on the sum of your 401k.
But the best part?
You benefit more from having a retirement fund at a younger age.
Well the first answer might seem a bit obvious:
The longer you save, the more money you'll have in the future.
But there's another key reason to start a 401k plan as soon as possible:
Younger employees have more time before they hit the age of retirement. This factor alone enables them to take greater risks on their investments since any impacts won't be as significant to them if they lose money compared to someone on the cusp of retirement.
What's more, such risks really pay off.
If you play your cards right when it comes to investing in a 401k, you can end up with a completely stress-free retirement in terms of finances.
In short, the benefits of 401k plans definitely outweigh any present inconveniences.
Although it's hard to part with a portion of your paycheck, setting that money aside now can make a world of difference later.
And in the scheme of things, only a very small portion of your check is cut. In most cases, you probably won't even feel the difference.
But that money will be your lifeline when you retire, so don't skimp on contributions --especially if your employer provides a matching contribution.
You wouldn't say no to free money, which is essentially what your employer is giving you when they set up a 401k account in most cases.
It's plain and simple:
The smartest thing to do is to take advantage of it.
So learn as much about retirement plans, IRAs, and the rules behind 401ks now. Believe me, if you do, you'll want to hug yourself when you turn 65.