CHARLOTTE, N.C., May 10, 2007 – A 401(k) is a great way to invest in your future. This particular type of retirement plan was created in 1978 to encourage Americans to save more by easing the tax burden for participants. It’s called is a “defined contribution” plan. (Other examples are IRAs and some profit sharing plans.) A 401(k) is set up and administered by employers on behalf of employees.
Here are some of the benefits of a 401 (k) and why contributing to this kind of retirement savings account is so important:
1. Save on income tax – Taxes on 401(k) contributions and earnings are deferred, meaning you don’t pay the IRS on that income until you withdraw it. Assuming you don’t access your 401(k) until retirement, when you have a much lower level of income, your tax rate on that money will be lower than when you earned it. In the meantime, the percentage of your paycheck that is contributed to your 401(k) is made before taxes are withheld, thereby reducing your taxable income.
2. Employer-matched contributions– Many companies provide a matching contribution, which essentially means they are paying you tax-deferred income above and beyond your salary. Let’s say you participate in your employer’s 401(k) program, contributing 10% of your paycheck and your company matches 50%. If our base salary is $1000 per pay period, then you are contributing $100 and the company is matching your contribution at 50% ($50) – that’s a $150 investment per pay period, $50 of which the company is giving you, tax-deferred, just for participating in the savings plan.
3. Your 401(k) stays with you– If you change jobs, you can roll your 401(k) account into your new employer’s plan, or into another type of retirement account. Plus, a 401(k) is not just for employees of big companies: even sole-proprietorship businesses can set one up.
4. Flexible options – A 401(k) is not a single investment product, but rather a type of account that can include any number of different investment types, usually mutual funds. Typically, the plans are run by a reputable third-party investment firm or other financial institution and you can often choose between a variety of investments, depending on your risk-tolerance.
5. Savings are automatic – Because your contribution is withdrawn from your paycheck before you receive it, you are never tempted to put off saving, or put the money to some other use. For this reason, a 401(k) is sometimes called a forced savings plan.
This doesn’t mean you can’t access the money in your 401(k) if you need it in an emergency. However, withdrawing money prior to retirement could precipitate penalties that wipe out the benefits of your contributions.
To see if a 401(k) is right for you, consult a financial advisor or check any number of online calculators to see how much you might save, how compound interest works and how much you might save on taxes. In addition, check with your employer for any company-specific benefits and restrictions.
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