Private Sector Employees Can Invest for Retirement With a 401(k) Plan
Years ago, it was common for employers to offer a pension plan to support workers after they retired. Over the past few decades, however, most employers have stopped offering pensions, and many offer a 401(k) retirement plan instead.
A 401(k) plan is a qualified plan that includes a feature allowing an employee to elect to have the employer contribute a portion of the employee’s wages to an individual account under the plan. The underlying plan can be a profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan. Generally, deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reported as taxable income on the employee’s individual income tax return.
With a 401(k) plan, you are in charge of your retirement account. That means you are in charge of how much money you will have in retirement. While that may seem intimidating, the biggest step is simply to start contributing to your plan.
And remember, you don’t have to go it alone. A financial planner can help you make decisions that reflect your goals and risk tolerance.
In general, a 401(k) is a retirement account that your employer sets up for you. When you enroll, you decide to put a percentage of each paycheck into the account. These contributions are placed into investments that you’ve selected based on your retirement goals and risk tolerance. When you retire, the money you have in the account is available to support your living expenses.
Your 401(k) contributions are deducted right from your paycheck and go directly into your account before taxes are withheld. So if your salary is $50,000 a year and you contribute $3,000 to your 401(k), you will pay income tax on $47,000 next April instead of the entire $50,000 that you earned. When you withdraw money from your account in retirement, it will be subjected to taxes. But since you’ll be retired, you’ll possibly be in a lower tax bracket. Consider taking full advantage of the tax-deferral by contributing the maximum amount allowed by your company. Check with your human resources department for limits and details. Please keep in mind that all investing involves market risk, including the possible loss of principal.
Your company may match a certain percentage of your 401(k) contributions – most do. For example, if your company matches 0.5% for every 1% you contribute up to 6%, that translates into an extra 3% in your account if you take advantage of the entire match. With the example above, your $3,000 contribution plus your employer’s match would add $4,500 to your 401(k). (Your company will have rules about when the entire match is yours. Get the details from your employer.)
Since 401(k)s are designed to help you save for retirement, there are penalties for taking your money out early. You’ll owe income taxes on the total amount and, if you’re younger than 59½, also may owe a 10% early-withdrawal penalty. Plus, the IRS requires your employer to withhold 20% of your account value to pre-pay at least part of the taxes you’ll owe.
Investment advisory services offered through Allmerits Asset Management, LLC, a Registered Investment Adviser firm. Allmerits Asset Management does not provide legal or tax advice. Investment Adviser Representatives of Allmerits Asset Management may only conduct business with residents of the states and jurisdictions in which they are properly registered or exempt from registration requirements. Insurance and Annuity products are sold separately through Allmerits Financial and Insurance Service. Securities transactions for Allmerits Asset Management clients are through Trust Company of America, TD Ameritrade, Nationwide, John Hancock and American Funds.