A 401k is a retirement plan offered by companies in which the employees contribute part of their salary with employers usually offering matching contribution.
Introduction A 401k is a retirement plan offered by companies to their employees. Employees can contribute part of their salary to the plan, invest in various mutual funds, and let it grow tax-free until withdrawal time. Contributions to 401k are tax-free (up to an annual limit) which will lower your taxes. On top of that, most companies provide matching contribution.
Pros
- 401k money grows tax-free until withdraw time post retirement, thus providing better returns compared to taxable account
- Employer matching contributions are like free money
- Contributions are automatically deducted from your salary
- You will probably be in a lower tax bracket when you take money out during retirement
Cons
- The 401k plan investment choices may have mutual funds with high fees
- You will eventually pay taxes when you take the money out
- There are early withdrawal penalties if money is taken out before retirement
I am not sure if I can save part of my salary
What if your employers offers you a 5% raise. Will you ever say No? Never!
That is effectively you are doing by not contributing part of your salary to 401k, assuming your employer matches your contribution. Even if there is no matching, you are still saving money on taxes while securing your retirement.
I am afraid of losing money in stock market
It is a valid concern! Although no one can predict the future, US stock market has always bounced back after every crash.
Money invested in 401k is for the long-term retirement purpose. There will be short-turn bumps but if you stay the course and not panic, then you will come out a winner in the end.
Additionally, there are various strategies (Ex. Dollar cost averaging) to overcome unique risks to your situation that allows you to invest money in higher or lower risk options.
What happens to my money if I change jobs
When you change your job, you can:
(1) Rollover money from previous employer plan to new employer 401k plan
(2) Rollover money to IRA (Individual Retirement Plan)
Remember, 401k money belongs to you! You have full control over what to do if you change your job.
Action Items to start 401K
- Decide what percentage of your salary you can contribute to your 401k
- At a minimum, contribute to take full advantage of your company matching
- Work with your company HR to set up your 401k Account
- Select which mutual funds to invest in
- Start by investing in target-date funds as they choose allocation per your retirement age
- As you get comfortable, you may want to invest in a mix of Index Funds and Bond Funds
- Set up to automatically deduct money from you salary
That’s it! Sit back, relax and watch your money grow over time!
Final Verdict
For salaried people, contributing money to 401k account is one of the best way to save for retirement, get free-money from employers, reduce taxes and comfortably save for retirement.
The key is to start early, contribute regularly and let your money grow over time!
We hope the information in this post will be helpful in your journey of aspiring nirvana!