One of the most important strategies of retirement planning is to participate in your employer’s 401(k) plan. Your company may match your contributions, increasing both principal and interest by adding to your account balance at no cost to you.
Benefits of a 401(k)
The tax benefits of a 401(k) plan are outstanding. Most individuals, especially new graduates, fall into the 25 percent tax bracket, earning between $30,000 and $60,000 a year. If you contribute only $1,000 to your 401(k) plan, you are essentially giving up only $750 of your paycheck when you consider the tax advantage. Moreover, the money is tax-free until you take it out of your plan 40 years down the road.
With a 401(k) matching program, the opportunity to receive free money from your employer is there for the taking. Depending on how your employer match works, you might increase your entire investment by 25 to 100 percent.
Investing goes a long way when you have a 401(k) plan. Even if you put only a small amount into your account now, by the time you withdraw it in 30 to 40 years, it will have become a substantial amount of money.
Company Matching Programs
Some companies offer a variety of 401(k) plans while others offer only one plan or no plan at all. Of those that do offer plans, some provide generous matches to their employees’ contributions, others provide small matches, and still others provide no match.
One option is a 50 percent match up to the first 6 percent of your yearly salary. For example, if you earn $50,000 a year and contribute 6 percent, or $3,000, to your plan, your employer will contribute $1,500.
A dollar-for-dollar match is also popular and is self-explanatory: for every dollar you contribute, your company will also contribute a dollar. This plan typically goes up to 5 percent, though, so once you reach 5 percent of your annual salary, your employer will stop contributing until the next year.
What Not to Do
The worst thing you can do is not sign up for a plan if it is offered. While some employers offer very unappealing 401(k) plans, these instances are rare. There is no reason why you should not invest at least a fraction of your salary into a plan that will help you save for your retirement. Even if your company does not offer matching contributions to its 401(k) plan, by making contributions yourself, you’re automatically saving money you may not save otherwise.
Do not take a loan on your retirement plan. While it may seem like a great idea to borrow your own money and pay yourself the interest on your plan, the idea has underlying traps that could hurt you later in life. What happens if you lose your job? You’d still have to pay back the loan, and if you could not pay it back soon enough, you would owe even more money due to taxes and penalties on the amount your borrowed.
Avoid cashing out your 401(k) account if you lose your job. Don’t figure that if you have the money now, you might as well use it. If you leave the money alone, you’ll earn tax-deferred returns for many years. Instead of tapping into your retirement fund, consider rolling that money over to an individual account or to your next employer’s 401(k) plan.
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