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401K Services Business Guide: Understanding Taxes, Contributions, & Benefits

A 401K is a retirement savings account that must be sponsored by an employer or other organization. A specific amount is taken out of your paycheck each week and placed into an interest-bearing, tax-deferred savings account. Taxes on the account are not paid until you withdraw the money.

Benefits

There are a wide variety of plans that can help nearly anyone who wants to get a start on their retirement. The 401K Roth is funded with income before taxes have been taken out. The individual 401K is specifically designed for self-employed individuals. 401K savings plans can be funded with stocks, bonds, mutual funds and even real estate. The main limitation on IRA contributions is that the savings can only be funded with cash or cash equivalents.

Deferred Taxes

The income that goes into a 401K each year is not taxed on your income taxes. The amount that is contributed by you is subtracted from your income and is not calculated as income on your Federal income taxes at the end of the year. There are limits each year on how much you may contribute. If you are over the age of 50, you may contribute additional amounts to help you get caught up on your savings.

Free Money

Companies generally match your 401K contributions up to a certain amount. What this means is that for every dollar that you contribute, the company will match that dollar up to a capped amount each year. This is free money for retirement. This savings account will continue even after you leave the company. Some companies do require that you pay a small fee for them to maintain the account for you if you are no longer with them. You may also move the 401K to another professional financial institution and continue contributing.

Different Yields

The type of contribution you choose to make can actually increase your 401K quickly. This is especially useful for individuals who get a late start on their retirement. An aggressive 401K uses stock options. Stock options fluctuate with the economy, which means you can lose money just as easily as you can make money. Taking advice from a financial advisor can usually be in your benefit and will net you more money than if you had contributed with your income alone.  The result is a larger retirement savings.

Interest

A 401K-retirement account is an interest bearing account that compounds very quickly, which allows you to save for retirement faster than a regular interest-bearing savings account. If you are young when you start investing, you should invest aggressively. Middle-aged individuals should choose a moderate risk. As you approach retirement age, choose the safest investment.

Pitfalls

Not Participating

One of the biggest mistakes you can make is not participating in a 401K plan. By contributing a small amount of your pay at a moderate risk, the amount in your savings will increase very quickly. You will likely not miss the amount taken out of your check since you won’t see it. If you are worried about contributing a large amount at first, then commit to a small amount. You can transfer more money into the account at the end of the month if you find you have money left over or if you see you can invest more.

Not Contributing Enough

Contribute enough to take advantage of the maximum amount matched by your company. If you do not contribute enough you are throwing free money away. This is money you cannot get back when you reach retirement age.

Borrowing

Resist the urge to borrow from your 401K. As you see the funds increase you may be tempted to borrow the money now. Each time you do you will be taxed a heavy amount. The results are not worth it in the long run and you will regret it.

Cashing Out

Do not make the mistake of cashing out your 401K now with the intentions of beginning another one. The Federal government will take a substantial amount of your savings if you have not reached retirement age. This is money that has taken you time to accumulate and will take you longer to replace. Keep the money and find other ways to get the funds you need.

A 401K plan is one of the most important investments anyone can make for their future. Social security age limits have been raised and the dwindling funds have left many to question whether baby boomers will benefit from this program at all. The future of social security is in question, which leaves you with the responsibility of funding your own retirement. Start saving now, so when you reach retirement age you will be able to enjoy yourself. If you wait until you are retirement age you can withdraw the entire amount of your 401K without the hefty charges that come with early withdrawal. You will also have a living wage in your senior years that is not dependent on others.