One of the primary and most important financial plans ever made is retirement planning. 401(k)s are unique investment tools that can be a foundation piece in your portfolio. If the company you work for offers 401(k) savings with matching gifts, you have hit the lottery. According to the Internal Revenue Service, the 401(k) offers a pre-tax benefit. Many economists and financial advisors, such as Professor of Economics Leslie E. Papke, of Michigan State University, feel 401(k) investments should be maximized before another investment is made. Find out what a 401(k) is and if it can help you invest in your retirement.
Definition of a 401(k). The 401(k) is a form of retirement savings account. The name 401(k) refers to a section of Title 26 of the Internal Revenue Code that states a contributor can withdraw funds once he or she turns 59 ½ years of age. The 401(k) became a common retirement plan in the 1980s, replacing the once traditional retirement pension paid for by the employer. Employers may offer a 401(k) to workers, but may or may not contribute to the savings account. The 401(k) shifted retirement funds responsibility from the employer to the employee. 401(k) account earnings are not taxed until earnings are withdrawn. Employers may match funds deposited by the employee on a pre-tax basis with or without a vestment stipulation.
Why is a 401(k) good? This type of retirement savings account has several benefits. The money you invest is taken from your paycheck before taxes and stays tax-free until you withdraw funds. If your employer offers matching funds, even if it’s only a fraction of your investment, that’s free money to you. Make sure you know if the company matching funds are only ensured after a period of time with your employer. The human resource department will have the details that outline the 401(k) stipulations. If you are not vested, the money that your employer contributes is taken back if you leave the company before that time. Another benefit to 401(k) retirement savings accounts is the accrued, compounded interest. The interest that is compounded over time incrementally may not seem like much at first. Through the years, however, the investment in a 401(k) can be the foundation of your retirement income.
What are the limitations of a 401(k)? This company offered retirement savings account is not selected by you. Your employer puts the plan together with the options and selections within the prospectus that it chooses. An investment you might make on your own could have completely different options, tailored to your desires, needs and requirements. A 401(k) is not uniquely fit to anyone’s needs but is a one-size-fits-all approach with a few select options. For this reason, you should check the Morning Star ratings on the investments within the 401(k) that your company offers. An “A” rating is a good bet. If the Morning Star rating falls below “A” you may wish to forgo the company 401(k), and set up your own retirement investments. Understand that if you liquidate your 401(k) before the retirement age, you are subject to pretty substantial tax penalties. Find out exactly what amount of taxes will be imposed before liquidating your plan. It might be best to leave the 401(k) alone and simply begin anew to avoid those penalties.