February 3, 2009
by Mike Rowan, eRollover.com
If your company offers a 401(k) plan, you should take advantage
of it. Since their inception in 1981, 401(k) plans have made saving
for your retirement particularly easy, provided the company you
work for offers such a plan. The idea is that money will be
deducted from your weekly salary and put into your own retirement plan .
Typically, you’ll need to work at the company for a specified
amount of time before you’ll be allowed to participate.
In addition, there may be a company 401k match, where your employer
“matches” your 401k investment up
to a certain percentage or dollar amount. This 401k match is often as much as 50 percent of
each dollar, and up to six percent of your salary. This is
essentially free money for the you, the employee.
Within the plan, you’ll be able to choose from a number of investment options. Your plan will generally provide a range of different fund choices. Generally, you retain control over the mutual funds in which youinvest your 401k investment. It is extremely important to come up with a good game plan for your 401k. This means researching the available mutual funds and coming up with a 401k allocation, or percentage that will be invested in each one. This is usually based on your age, date of retirement, and how aggressive you would like to be with your 401k.
Your 401k is Pre-Tax MoneyA 401k also helps you reduce your taxable income. Contributions are deducted from your pay before taxes are withheld, reducing your gross, taxable income. As a retirement plan, you save money because there is tax-deferred growth, meaning the money in the plan compounds without being taxed each year.
Since the 401k is a retirement plan, you need to leave the money in the plan until the age of 59½. If money is withdrawn earlier, you will generally pay taxes plus a 10 percent penalty, in addition to ordinary income tax. This 401k penalty should be avoided as it could cause over 40% of your retirement funds to evaporate overnight.
Taking distributions from your 401kThere are certain hardships, such as disability, that allow for taking money out of a plan before age 59½, and sometimes first-time home buying can be a reason to withdraw money without penalties. You’ll have to read the fine print of the plan carefully, as the details will vary from plan to plan. If you really need money, many plans allow you to borrow some portion of the money in your plan. However, you usually have to pay it back with interest.
Rolling over your 401k to an IRAShould you change jobs, you can, by law, roll over the money into the 401(k) plan of your new employer. You can also roll over the money into an Roth or Self Directed IRA. You need to do a direct trustee-to-trustee transfer to make sure you are not taxed on the money.
When you reach the age of 59½ you can start withdrawing your money from the plan or roll it over into an IRA. There are options for receiving distributions, which can be in a lump sum payment or through periodic distributions.
Your 401k is probably the best tool for the average investor’s goal of retirement. If you follow a few basic rules, and keep your eye on your goals, your 401k can provide you with a bountiful future!
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