401(k) – Smart Planning for the Future

Whether retirement is five years down the road or 40 years down the road, it’s wise to have a financial plan in place. That’s why many employers offer what is called a 401(k) plan. The term 401(k) comes from a tax code within the IRS.

A 401(k) plan is a way to save money by deferring a portion of paycheck to the 401(k) sponsor – most of the time arranged through your employer. Most people elect a certain percentage of their check to be deducted each pay period to put towards their 401(k). Many times employers offer a matching incentive, where they contribute or match your investment.

The money that is put towards your 401(k) is then invested. Companies hire a firm to take 401(k) contributions and invest them in mutual funds, stocks, bonds and/or securities. This way the money you’ve set aside can grow by earning interest. There is some level of risk involved by investing money this way. However, because 401(k)s are long-term investments, this minimizes the risk.

Another way you’re able to reduce risk is by helping choose where your money is invested. Many companies that sponsor 401(k) plans let you choose what percentage of your 401(k) contribution goes where. Today, much of this can even be done online.

Your 401(k) is also protected against creditors. If the company you work for goes out of business, your employer’s creditors are not allowed to take money from your 401(k) plan to pay the company’s debt.

One of the major reasons many people choose to save for retirement through a 401(k) plan is the tax savings. Money that is put towards a 401(k) plan is considered deferred payment and is not taxed by the government. The IRS code that defined this rule is labeled 401(k) and where the term 401(k) for retirement plans came from. Once the IRS introduced the 401(k) rule, many employers started offering what they called 401(k) plans.

You’re able to keep your 401(k) plan until just after you turn 70. Then it is required that you begin to withdraw the money. However, there are times when you can withdraw the money early. If you leave the company you’re working for, laid off or fired, you can withdraw your 401(k) contributions. After you turn 59 ½ you can begin to withdraw funds without penalties. If you pass away, the funds can be withdrawn on behalf of your estate.

If you choose to withdraw funds from your 401(k) before you turn 59 ½ (excluding transferring your 401(k) to a new employer), you will have to pay heavy tax penalties. There’s a minimum 10% tax on 401(k) funds that are withdrawn early. On top of the 10% penalty tax, the money you withdraw is considered income and therefore may be subject to income tax as well.

If you leave your company, your 401(k) is still your own retirement account. You are allowed to leave the 401(k) many times or take it with you to your next employer. You just simply contact your 401(k) sponsor company, and one of the customer service representatives will be able to help you make sure your 401(k) is transferred properly.

While it is highly encouraged to invest in a 401(k) plan, there are some limits as to how much you can invest on a pre-tax basis. Not every year has the same limit, so it’s best to check with your employer or your 401(k) sponsor company to determine the maximum amount allowed on a pre-tax basis. Also, employers can only match your 401(k) investment up to a certain amount – these amounts also change depending on the year.