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What you Should Know About your 401(k) Plan
Planning for retirement is one of the single most important things a person can do continuously throughout their entire life. From the time you begin working, it is vital to have a solid strategy with achievable goals in mind. The sooner you begin this planning, the more money you will have with which to enjoy your twilight years.
One of the most common methods for a working individual to save for retirement is a 401(k) plan. A 401(k) is a type of savings account that uses defined contributions in order to grow. This means that the amount of each contribution is predetermined and stays the same unless paperwork is filed to change the amount. The 401(k) plan takes its name from the corresponding subsection of the Internal Revenue Code.
A 401(k) provides many advantages and benefits when used by most working people. These include
- Tax Advantages: When a contribution is made to a 401k plan, the money is taken out before taxes are assessed. Taxes are only taken out when the 401(k) owner withdraws money from the account. This is called “tax deferred.” By being tax deferred, the money in the 401(k) can grow much more rapidly than if taxes were taken out prior to deposit.
- Flexibility and Diversification: Employers that offer a 401(k) to its employees provide a wide range of different choices on how they can have their money invested. Some investment choices bring a higher rate of return. However, these choices also bring a higher risk factor. This customization allows each person to tailor their 401(k) to their personal preferences.
- Employer Matched: One of the most popular features of many 401(k) plans is that the employer will match the all or part of the amount that the employee contributes to it. This means that for every dollar that a person contributes from their paycheck, the employer will also put either a whole or part of a dollar into the account. In essence, you could potentially double the amount that goes into your 401(k) account.
- Loans: In times of financial hardship, it may be possible to borrow money from your 401(k) account. Instead of having to go to a bank or outside lending institution, the money is in essence coming from you. Interest is still paid on the loan. However, this is usually regained at or near retirement.
- Rollover: If you decide to take a new job, it does not mean that you should withdraw the money from your 401(k). This can result in a wide range of fees and penalties that can seriously impact your retirement portfolio. Instead, you can simply have the money transferred from your past 401(k) into the one you have with established with the new company. Since you do not touch the money yourself, all of the associated fees are bypassed. This is called rollover.
One of the most important things to examine when deciding which 401(k) you should invest in is what fees are associated with it. There are three main categories of fees that can be assessed. There are also additional fees you can incur based on different actions you take.
- Administrative Fees: As with virtually everything in the modern world, a 401(k) requires administration in order to run effectively. Record keeping, customer service and accounting are examples of some of the administrative costs associated with a 401(k). In most cases these fees are paid by the employer that offers the 401(k). However, there are different optional administrative fees that the plan owner may have to pay if selected.
- Investment Fees: The profit in a 401(k) is made by investing the money contributed by the plan owner or employer. There are different costs that are associated with investing that must be paid. These include trading fees and the hiring of the managers of the fund itself. Usually these fees are deducted from the money that is earned through interest and dividends.
- Individual Service Fees: Many different 401(k) plans have different benefits that can be used on an individual basis. One of the most popular benefits is investment counseling. Another is shifting your assets around to different types of investment mediums on a frequent basis. Since neither of these benefits are free, the cost is then passed on to the 401(k) owner.
- Withdrawal Fees: This actually covers a wide range of optional actions you can take with your 401(k) plan. If you need to take a loan from your 401(k) plan, the interest, and any charges, would fall into this category. If you need to withdraw money on a permanent basis instead of a loan, sizable fees will be assessed on top of any associated taxes.
There are a couple of important terms to be familiar with if you are looking into any type of 401(k). These can include:
- Compounded Interest: One of the most advantageous aspects of a 401(k) plan is compounded interest. This is defined as interest that has accrued that is added on to the principle. This money will then earn interest as well. Over time, compounded interest is one of the most effective means by which a 401(k) plan grows.
- Limits: There are limits to the amount of money that a person can contribute to a 401(k) plan each year. For 2012, this limit was set at $17,000. There are also limits to how much a person can take out as a loan from their 401(k). In most cases, this would equal out to 50 percent of the total dollar amount in the plan. The maximum amount would come to $50,000.
In the past, it may have been sufficient to count on Social Security to cover all or part of your expenses after retirement. However, it is becoming more and more possible that Social Security may not be available for all those who are working today. In addition, the amount paid by Social Security is not enough to live on comfortably. As a result, investing in a 401(k) plan, as early as possible, is one of the best financial decisions a person can make.