401(k) Basics

10 (1)Congratulations! You got your first job! Did you know it’s already time to start saving for retirement? If you work for an employer you will likely have the ability to contribute to a 401(k) retirement plan. A 401(k) is a type of retirement plan only offered by employers named after a section of the Internal Revenue Code. Employees can contribute a designated amount to this plan, pre-tax each paycheck. There are many reasons why 401(k)s are a great benefit to working for an employer, but it is important to educate yourself on the benefits before jumping in.

Important Questions to Ask

Will you be automatically enrolled?

An increasing number of companies are moving towards automatic enrollment and annual percent increases in contribution amounts. Find out if you will be enrolled, and if not, what the procedure will be for enrolling. Once enrolled, you can change you contribution rate through your employer at any time.

What’s your company willing to match?

401(k)s are common throughout many industries, however, each plan and benefit is structured differently. It is important to ask if your employer will match contributions to your funds. Many companies will match half of 6%, or 100% of 3%, make sure you know so you don’t inadvertently leave free money on the table.

How much will it cost?

It’s also important to know the fees associated with the account. Just like other plans, 401(k)s assess a fee on earnings. Knowing that number can help you make an educated decision. You can find out about fees by calling the financial institution that houses your company’s 401(k).

What loan options are available?

401(k)s generally allow you to borrow from the account for a fee. You are charged an interest rate on the loan, however, that number goes back to your account and may be a financially beneficial option for an expense down the road. Keep in mind you usually have to pay the loan in full by 90 days if you leave your company.


Matching Contributions

Many employers offer matching contributions which is basically free money. For example, if you make $50,000 and contribute 6%, and your employer matched up to 3%, you will contribute $3,000 per year and your employer will contribute an additional $1,500 to your plan at no cost to you. If you contributed 2%, your employer would contribute 2% as well. Over time, this can become a meaningful amount of your retirement fund.

Tax Advantages

401(k) plans allow you to move your dollars into your account on a pretax basis. This means that your money is moved before it is assessed federal income tax. For instance, if you contribute $100 per paycheck and your federal income tax rate was 25%, you would contribute $100 to your plan, instead of receiving $75 in your paycheck after the federal income tax deduction. In addition, unlike several other kinds of retirement investments, your 401(k) earnings are tax deferred. This means that your earnings are not taxed until you make a withdrawal.


Administrative Costs

401(k) plans tend to be an expensive employee benefit and those costs are passed down to the employee with higher fee structures than other savings plans. Make sure to understand your fee structure as well as other opportunities before jumping in. Many times, an employee match will quickly outweigh these costs, but as with everything, knowledge is power!

Low Performance

401(k)s tend to have moderate earnings compared to other investment opportunities. Be sure to track your funds performance and assess your earnings regularly.

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