The ABCs to a 401(k) - Quicken Loans Zing Blog

Are you new to the working world? If so, the single best piece of advice I can give is to contribute to your employer’s 401(k) program. What’s a 401(k) program, you ask? And why should you contribute? Both good questions.

What Is a 401(k)?

A 401(k) is a retirement plan and a special type of account funded through pre-tax payroll deductions. It’s made up of stocks, bonds and mutual funds. If you’re signed up to contribute to your 401(k), you must determine how much money you’ll pay into your account per pay period.

What Are Some Benefits of Having a 401(k)?

There are some big benefits to gain from having a 401(k). For starters, as a pre-tax account, dividends, interest and capital gains are not taxed until they’re dispersed which means that’s more money earning interest while it’s sitting in your account.

Another attractive aspect is that many employers have a match program where they contribute a percentage of the employee’s contribution. For example if your employer matches at 4% and you are contributing $100 a month to your 401(k), then your employer would also contribute $4 to your 401(k) per month. Most commonly, employers match 50 cents for every dollar you contribute up to 6%. All employers have a matching cap, so anything beyond their threshold is just extra contributions to your account. An important thing to note is even after your employer has contributed to your 401(k), you don’t get to keep the money until you are vested in the retirement plan. Being vested typically takes three to five years of employment with your company.

Not that a 401(k) is intended as a loan source, but the ability to cash out your 401(k) funds in a time of need is another benefit worth mentioning. This isn’t the greatest decision since you must pay a 10% penalty fee to withdraw. (In most cases, you must pay the 10% penalty unless you withdraw after age 55.) By withdrawing, you lose the tax-deferred interest compounding on your money. Also sometimes there are limits on how much you can withdraw at once.

Another 401(k) benefit is the fact that most employers provide a variety of choices how to invest your assets. Whether you are a play-it-safe investor or a high-risk investor, there are typically investment options to fit your financial goals. In 2011, the average 401(k) plan offered 19 investment options. And you don’t have to worry, because you can always seek professional guidance from account advisors.

Another plus is that your retirement account follows you throughout your professional life. So when you change employers, you have the option of rolling your 401(k) into your new employer’s program or moving your money into an Individual Retirement Account (IRA). This way, your capital continues to grow in a tax-deferred account.

Only about half of companies will allow you to start participating in their 401(k) program upon your hire date. Others, require employees to wait a few months, or in some cases a year before you can participate. All 401(k) accounts have limits as to how much can be invested annually. Your contribution limit depends on your plan, salary and government guidelines.

If you work for a nonprofit organization, the retirement program is called a 403(b). These programs function just like 401(k) programs do.

If you want to learn more about 401(k)s or 403(b)s visit BankRate.com or ask in the comments below!

 

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