The 401(k) Plan And Retirement

By: Jody Smith

The Tax Reform Act was passed with the purpose of encouraging citizens to build up their retirement savings. The name of the new plan, 401(k), is derived from the section number and paragraph in which it appears in the Internal Revenue Code. When you invest in your company's 401(k) plan it will provide money from your employer, lower taxable income, automatic savings and earnings, and the opportunity to retire. The 401(k) plan is a favorite retirement plan. The sooner in your career that you begin investing in a 401(k) the better.

The 401(k) plan is one type of defined contribution plan, along with IRAs, Simple IRAs, money purchasing plans and profit sharing plans. Your employer or you as the employee, or participant, define the amount that will be contributed. The 401(k) is unique in several respects. Your contributions come out before taxes. You can choose the amount you want to be put in your account, up to 15 percent of your earnings per month. Your boss has the option to limit this amount. Some employers will match a part of your monthly contribution to encourage your participation in the plan. A third party administrator will invest the money in things like bonds, money market accounts or mutual funds, at your discretion. They will advise you, but you make the final decision.

The Employment Retirement Income Security Act protects your retirement income even if your employer goes bankrupt. All 401(k) deposits are in custodial accounts as a safeguard. Your boss is required to send you regular account statements, and to maintain easy access for you to your account, as well as to give you educational information concerning opportunities for investment.

A 401(k) plan is preferable to investing yourself in stocks because the contribution to a 401(k) is made before taxes, and sometimes you'll be getting a matched contribution from the company you work for. This will also decrease the amount of tax you'll pay on your earnings. On top of this, the tax on what your 401(k) investments earn is deferred until you retire when you may be in a lower tax bracket.

The 401(k) plan works best for you when you diversify your investments, optimizing the benefits of investing over the long term. This generally will bring better results financially than investing your retirement funds in short-term market fluctuations. These short-term fluctuations can be quite dramatic. Long-term investment strategies tend to do their rebounding and in the end, return to the original or higher levels.

Be aware that if you opt to take your money out before you are 59.5 years of age, you will pay taxes on it as well as paying the IRS a 10 percent penalty.

Jody smith is a freelance writer for EmpowHER.com.


Sources:

How 401 k Plans Work

http://money.howstuffworks.com/personal-finance/retirement-planning/401k.htm

How 401 k Plans Work

http://money.howstuffworks.com/personal-finance/retirement-planning/401k2.htm

401(k) Plans

http://www.irs.gov/Retirement-Plans/401(k)-Plans

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