Retirement Plan Basics
your employer offers a 401k retirement plan,
take advantage of it. You get some nice benefits if
you do. Participating in your employer 401k plan helps
you save for retirement, get an instant return on
your money (maybe 50% - 100% depending on your employer's
plan), lower your taxes and not pay a dime of taxes
while you are saving! If you don't choose to invest
in your employers 401k you are leaving money on the
table! Here's why...
you enroll in a 401k retirement plan, your employer
will typically match a certain percentage of the
amount you contribute. For instance, if you put
in a dollar and your company offers a 50% match, that
means 50 cents is invested in your 401k account by
your company. There's your 50% return. Some employers
offer higher matching contributions. Mine is generous
enough to match dollar for dollar up to 3% of my salary.
And that brings us to the next concept you need to
matching funds are up to a certain percent of your
salary. Let's say you earn $50,000 a year. If
your employer matches dollar for dollar up to 5% of
your salary, that means they will contribute $2,500
into your account. ($50,000 x .05 = $2,500) You just
gave yourself a 5% raise!
good? It keeps getting better. Using our example above
and you contribute 5% of your salary ($2,500) you
are also reducing your taxable income by that
exact amount. When you pay your taxes, your taxable
income is $47,500 ($50,000 - $2,500).
advantages continue. The entire amount in your 401k
is allowed to grow, year after year without paying
a dime of taxes. In a regular investment account,
you would have to pay taxes on any dividends or capital
gains that you earned. The government stays away from
your account and allows it to grow without taking
1 penny for taxes. This can lead to huge differences
in the amount in your account when you reach retirement
because of the power of compounding.
401k retirement plan considerations
happens if you leave your employer? Going back
to our earlier example, a total of $5,000 ($2,500
was yours and $2,500 was your employer's) was invested
in your 401k retirement plan. That's your money right?
Well, not exactly. The money that you put in, and
the investment returns that it earned are entirely
yours. However, the amount the employer put in for
you may not be yours. This is what is called "vesting".
401k retirement plans have vesting schedules
which stipulate what amount of the employer match
is yours if you leave the company, based on how long
you were an employee. An example would be 25% after
the first year, then 50%, 75% and 100% after the 4th
are your employer's 401k investment options? One
caveat is if the 401k is completely invested in company
stock. Remember Enron? Those employees held their
401k's in Enron stock and many of them had their entire
retirement accounts completely wiped out. Make sure
you have the option to invest in mutual funds which
diversify your investment. Your employer stock and
company may be a great investment, but never put your
eggs in one basket.
are the 401k contribution limits? In 2004 the
limit was $13,000. The limits in 2005 and 2006 are
$14,000 and $15,000 respectively. After 2006, the
limits are increased by $500 increments.
can I find 401k calculators? Below are some links
to test different scenarios that take into such factors
as account employer match, contribution limits, investment
returns and how long until retirement.