The Importance of 401ks

A 401(k) is a type of retirement plan sponsored by your employer. There are several key benefits to participating in a 401(k).

First, money deposited into the account is taken directly out of your paycheck before taxes are assessed. In essence, the money is tax-deductible at the present time, and taxes need only be paid at withdrawal from the account in retirement. This is an enormous tax advantage, because more cash is able to grow in investments up front, providing for a larger balance at retirement.

The second important benefit is that many companies choose to participate in a employer matching program. This means that, up to a certain percentage of their choosing, they will match dollar-for-dollar the entire amount you deposit each year. What this means is that you are basically giving yourself a raise by participating in a 401(k), not to mention that this money is also completely tax-free.

Some companies also allow their employees to purchase stock in the company and deposit the shares in a 401(k). This is beneficial if you believe that the company is growing and stand to profit from your own efforts at work. Other companies also participate in profit-sharing, which distributes excess profit at the end of the year into employee’s 401(k) plans, of course completely tax-free.

In a self-directed 401(k), the most common type, the company’s investment advisors or 401(k) plan agents select a number of investment choices for the employees to choose from. They act as filters to select what they believe are the best investment opportunities for the current and future markets, and usually monitor these choices carefully on a daily basis. The employee is then free to select percentages they would like purchased of each investment from every paycheck.

Not to worry if you decide to leave your company for any reason. 401(k) plans are transferable, and you can also “roll over” a plan into an IRA investment account at any other brokerage firm.

Typically, withdrawals begin at retirement, and there are severe penalties if you choose to do so before reaching the specified age. However, the tax codes do provide for withdrawals for certain “hardships,” such as buying a home or medical expenses. Many 401(k) plans also allow the employee to take a loan against the balance in the account, which must then be paid back at a specified interest rate back into the plan.

Whatever you plans for retirement, it is always a good idea to participate in a 401(k) plan if one is available, particularly if you are able to take advantage of plans like employer matching and profit sharing. Happy investing!