When it comes to investing in yourself, one of the most easiest and convenient ways is by contributing to a 401(k).
If you’re familiar with it, this article is going to be a wonderful refresher. If not, then we’ll educate you on what you need to know about a 401(k) and why it’s a smart investment.
What Is A 401(k)? And How Does It Work?
A 401(k) is a retirement plan that allows you to contribute pre-tax dollars. It is typically sponsored by your employer.
With most money transactions, the government adds a tax to whatever you do. But that’s not the case with a 401(k).
The plan allows employees to save and invest a portion of their paycheck. A 401(k) is a way for you to get more bang for buck because the contribution is untaxed.
However, when you make a withdrawal, you will then be taxed! But more on that later…
When Did 401(k) Plans Start?
The 401(k) originated in the late 1970s. That’s when the U.S. Congress enacted the Revenue Act of 1978, which included Section 401(k) of the Internal Revenue Code.
Section 401(k) stipulated that workers could defer taxes on compensation.
If You Leave Your Job, What Happens To Your 401(K)?
One of the most-asked questions is, “What happens to my 401(k) when I leave my job?” When this happens, you have some options:
- You may be permitted to keep the money with your old company, although you’re allowed to move it without being penalized by paying income taxes.
- You can “roll” your money to an IRA, (called a rollover IRA), which can be done by a banking institution of your choice.
- You could take a “lump sum distribution,” which means you can cash out. If you do this, you will be hit with steep “early withdrawal fee,” perhaps as high as 10% (those age 59.5 and up are exempt).
Where Does Your Money Go In A 401(K) Plan?
A 401(k) can be viewed as a savings account, but it is more or less an investment account. There are three entities that operate your investment account. They are either:
- A brokerage firm
- A bank
- An investment firm
Which ever one you choose, your money will usually get invested in mutual funds, stocks and bonds.
he money will be invested for your retirement, usually in your choice of a variety of mutual funds.
What Is A Traditional IRA vs. Roth IRA?
The primary difference between a traditional IRA and a Roth IRA is that a Roth IRA allows you to pay taxes immediately on your contributions.
This has several benefits, including the fact that you won’t be saddled with them when you retire on a fixed income.
Should You Open A 401(K)?
You should definitely open a 401(K) and the earlier the better. By some estimates, if you open a 401(k) with your employer when you’re 22 years old, you’ll have a $1 million in it by the time you retire.
If your employer matches your contribution (not all companies do), you’re in even better shape to fund your future retirement.
I hope this has been helpful so that you can see the benefits of a 401(k). If you have questions, let me know in the comments.
Interested in other ways to save or make money? Check out our Money Section:
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