401k

A 401k plan is a qualified retirement savings plan for employees sponsored by their employer. Your contributions and earnings in a 401k plan are considered pre-tax money and are therefore not subject to federal and most state income taxes until you withdraw funds. Most employers will contribute matching funds to make the 401 (k) plan even more rewarding. Usually, you will have the option to decide how much you contribute (up to the government maximum) and where you will invest your contributions (from an inventory of funds provided by your plan sponsor). If you are over the age of 50, there is a catch-up amount you can invest in addition to the maximum for each year.

Before taxes are withheld, your contributions will be deducted from your paycheck. This pretax deduction can be like getting a 25 percent rate of return on your investment, depending on your tax bracket, When you withdraw the money you will have to pay taxes on the money but the hope is you will be in a lower tax bracket when that time comes. Contributions are invested into the funds you select such as stock, bond, and money market funds.

Matching Funds

Some companies provide the benefit of a company match. It’s like earning free money. Once you enroll in your employer’s 401k plan, just contribute enough to earn your employer’s maximum matching 401k contribution. You should never contribute more than what your company matches. Any additional money you have could be invested in another strategy to supplement your retirement.

If your employer matches you dollar-for-dollar you will have already had 100 percent growth. Even if the match is only 50 cents on the dollar, that’s still an instant 50 percent growth, guaranteed! It is rare to get that kind of growth anywhere else.

Every company has a vesting schedule, and you need to know when you will become vested. The vesting schedule outlines the company’s matching contributions and earnings on those contributions you own at any time. If you leave the company before you become fully vested, you will lose all or some of the money in your plan.

Withdrawing Money from a 401k

Currently, the law requires that you begin mandatory withdrawals from your 401k plan by the age of 70 ½. You can avoid this withdrawal rule if you are still a full-time employee with the company sponsoring your 401k.

You may begin withdrawals at age 59½ without any early withdrawal penalty. If you have been fired by your company or if you become totally disabled, you are exempt from this penalty if you are over age 55.

A large number of employees take loans against their 401k plans, up to a maximum of 50 percent of their savings. If you pay back the loan (with interest) the money you borrow is not subject to the 10 percent penalty within the time frame established by your employer’s plan.

You have up to 5 years to repay the loan, but if you leave your job for any reason, it must be paid back fully within 30 days. If you fail to repay any amount it will be subject to the 10 percent early withdrawal penalty and taxes. Interest paid returns to your account.

Get Started

Investing in your retirement is a great way to start saving and accumulating wealth. Employee-sponsored 401k plans are convenient for employees. Once you start participating in a 401k plan, you should rebalance your investments regularly. Most companies have an open enrollment period where you can discuss your retirement goals with the plan sponsor. Once you have assessed your goals and your risk tolerance, you can look at ensuring your investments have the proper balance.

How should you balance a 401k?

Recommended allocations at three life stages:

Aggressive–with 35 plus years until retirement

• 55%–large-cap stocks
• 15%–mid-cap stocks
• 10%–bonds
• 10%–small-cap stocks
• 10%–international stocks

Moderate–with 20 years until retirement

•40%–large-cap stocks
• 25%–bonds
• 15%–mid-cap stocks
• 10%–small-cap stocks
• 10%–international stocks

Conservative— within 10 years of retirement

• 40%–bonds
• 25%–large-cap stocks
• 15%–mid-cap stocks
• 10%–international stocks
• 10%–cash

A 401k plan is an important retirement planning strategy. Make sure to learn everything you can from your employer about the plan that is offered. Gather information on such things as vesting, contribution limits, and matching funds. Research all of the funds offered for investing thoroughly. Regularly track your investments and ask for help when you feel your investment options aren’t performing adequately.