What’s a 401(k), Anyway?

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401k nest eggOur users have been telling us that they need to know what a 401(k) retirement plan is but the topic either daunts them, or worse, bores them.

We hear you and we get it. However, that’s no excuse. And, the longer you put dealing with it aside the more money you lose. And, we think retiring with no money is more daunting and boring!

So, we promise this will be painless. Let’s get started:

What is It?

A 401(k) is a free employer-sponsored retirement account that’s funded by contributions taken directly from an employee’s paycheck. And, in many cases, the employer also contributes a certain amount to an employee’s retirement fund—this action is called “matching.” Traditional 401(k) plans grow tax-deferred, meaning that taxes will only be deducted after withdrawals are made. (Ideally, at the time of retirement.)

There are a few considerations to keep in mind with 401(k) plans:

How Much to Contribute

Generally, people should contribute the maximum that they are allowed. However, we would never suggest that you leave yourself without enough money to live. The most important thing is to be saving as much as you can and getting as much from your employer as possible because, let’s face it, whether their match is dollar-for-dollar, or less, it’s basically free money. Think of it like a bonus! Today, the maximum pretax annual contribution an employee may make, including employer matching, is $16,500 (or, $22,000 if you are 50 or older).

Allocation

As the owner of a 401(k) plan, each employee is responsible for choosing her own investments. Most plans make this easy to do by offering a few investment options to choose from. However, before you should decide how to invest the money in your retirement account determine the level of risk that you are prepared to take.

Risk and Reward

Generally, the rule is the younger you are, the more risk you can afford to take. Workers in their 20s and 30s can afford to be more aggressive in investments. This means that you can invest your money in more stocks and specifically, in more high-risk and volatile stocks. The reason that you can afford to do this is because your account has more time to recover from any slumps that the market and the stocks that you have chosen to invest in may take. Then as you get older, you should start to move your money into more secure and stable stocks. To determine your risk tolerance, see our 401(k) and Roth Contribution Calculator.

To learn more, check out LearnVest’s Retirement Basics. It’s incredibly important to find out the ins and outs of your retirement plan. You MUST do this to save the most that you possibly can. Because….it’s not cool to be broke.

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  • MV

    Hi, my employer put me on a 401K without my knowing it?  I’m very annoyed and they haven’t responded to my questions (from 3-4 weeks ago) yet about this.   Today I noticed I was paid a lot for the work that I’ve done for 2 weeks (I was cut down to working only on Mondays) and I wonder if they returned the money from that 401K.  I never saw “401K” as a deduction on my paystubs.  Thank you!