401(k)’s are a staple of retirement planning. But despite their prominence in the financial world, many people don’t know too much about them. Maybe it’s the funny name, or maybe nobody really thinks about a 401k until they’re signing up for one. Either way, our credit counseling advice is to learn right now. Here’s the 411 on a 401k.
The 411 on Your 401k
What is a 401k?
A 401(k) is a retirement plan sponsored by your employer. With a 401k retirement plan, both you and your employer contribute to the account on a set basis. Employer contributions to your 401k are called a “company match”. The amount that companies will match for a 401k varies, but a common company match is 50% of your contributions up to a certain percentage. For example, if you contribute 2% of your weekly paycheck, your company will contribute an additional 1%. Take full advantage of employer contributions, as it is basically free money. If you feel comfortable, try to maximize your contributions to receive the maximum company match. Set up a direct deposit so a portion of each paycheck goes towards your retirement. If you want some assistance with planning your finances, try this financial planning worksheet to help.
The good thing is that you choose how much of your salary is set aside into a 401k. You can also change your investments and where your money is invested, so don’t feel too locked in to any decision you make. Another point to note is that any money put into your 401k is deposited before being taxed. But don’t think you get off Scott free; you will end up paying taxes on the money when you make withdrawals from your fund years down the road.
When Can I Access My 401k?
One question people commonly wonder about a 401k is when can I access my funds? Without incurring penalties, you can start withdrawing from your 401k pat age 59 1/2. This may seem like a long wait, but accessing your 401k before retirement age can be difficult and very risky. If for any reason you withdraw funds earlier, you will be subject to tax penalties. We highly recommend avoiding borrowing from retirement funds; it may cause more harm than good in the long run. If you are having trouble with money management or consumer debt, seek help to get back on track. Rather than having your retirement fund as a back up for emergencies, try setting up an emergency fund for unforeseen expenses instead.
Another important thing to note about your 401k contributions is that you can generally choose how much of your salary is set aside. But, for those of you making the big bucks, the IRS does put a cap on how much you can contribute to your 401k each year. This can be a bummer for anyone who wants to set a large portion of money without temptation of dipping in. As of 2016, the maximum a person under 50 can contribute is $18,000 per year. For workers 50 and older, you can contribute up to $24,000 annually.
What Should I Do with my 401k Contributions?
After deciding how much to contribute, many people wonder where do I put it all? Luckily, we have some insight on that, too.
You put your portion of 401k contributions into a portfolio of mutual funds composed of stocks, bonds, and money market investments. You will have to decide where to allocate your portion of money. With that said, try to have some variety. While you decide what level of risk you are comfortable with, it can be a good idea to disperse funds to a mix of high and low risk accounts to maintain balance. Especially if you are just beginning your career, consider putting funds into a higher risk investment, as you hopefully won’t need to touch the money for years to come. Riskier investments tend to yield higher returns, and if you set up a 401k at a young age, the money will have time recover from any potential losses. Keep in mind, it’s all about balance. It’s probably a good idea to balance out any higher risk investments by putting some funds into stable, low risk funds as well.
And, where you decide to put your money isn’t permanent. You always have the option to move your money around. For example, if you placed money into a higher risk fund at a young age but are now nearing retirement and want to ensure your funds are secure, moving to a lower risk fund may be a good idea.
It’s a lot to remember, but 401k’s aren’t too complicated once you dig into the details!
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