Understanding Your 401(K)

Understanding Your 401(K)

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Vacation time, free massages and product discounts are great company benefits. If your company perks include a 401(k), that’s even better.

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Vacation time, free massages and product discounts are great company benefits. If your company perks include a 401(k), that’s even better. It may just seem like more money taken out of your paycheck, but it’s really an easy way to save for retirement, and if your employer matches your contributions, then it’s basically free money. Now that we have your attention, here are the answers to some questions you may have about your new retirement account.

What is a 401(k) and how does it work?

After many people lost their pensions from bankrupted employers in the late 1970s, Congress proposed 401(k) plans as an alternative, more secure form of retirement savings plans. Named after the section of the Internal Revenue Code in which they appear, 401(k) plans are retirement savings plans set up by an employer. You can invest a portion of your paycheck into a 401(k) plan, essentially delaying when you get that money until retirement. The benefit of this is that you earn interest on that money, and you don’t pay any taxes on it until you withdraw it after you retire.

How much should I contribute to my 401(k)?

Many companies will match your contributions up to a certain amount, typically 3 percent of your salary. At the very least, you want to invest enough to take full advantage of this free money. Obviously, the more you can contribute, the better you’ll be set up for retirement. By law, those under 50 could contribute up to $18,000 per year in 2016. However, you want to ensure you have enough for your current living expenses, because it’s difficult to access these funds before retirement without incurring a significant penalty.

How much control do I have over what my 401(k) is invested in?

You decide how your money is invested by selecting from a variety of mutual funds, which include different mixtures of stocks, bonds and money market investments. Many plans offer target-date funds, which become more conservative as you get closer to retirement.

What happens to the money if I leave the company?

The money you invest in a 401(k) is yours, no matter what. Generally, there are three main options worth considering: keep the money in your old company’s plan, roll the funds over to your new company’s plan or roll them over to an IRA.

What if I need the money before retirement?

There are high penalties for withdrawing before retirement, which is why it’s so important to take into account your living expenses before investing. However, it is possible to access your funds earlier for certain expenses, such as college tuition or the purchase of a first home, if you follow specific regulations.

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