When you begin a new job, you are likely to be asked if you plan to join the company’s 401(k) plan. Retirement may seem a long way off when you are young, and you may wonder if you need to put in a large percentage of money or even participate at all. However, investing in a 401(k) plan is a smart move for your future at any age. Here are some facts you should know about participating in a company 401(k).
A 401(k) is an employer-based retirement savings account, and its name is derived from the tax code. The funds you and your employer contribute to your account are pre tax money. This means that your taxable income is lowered, and it reduces your current tax bill. The funds in your account grow without being taxed, increasing your income potential.
Generally speaking, the money in your 401(k) is meant to stay there until your retirement. However, you can usually borrow money from your account if necessary. There may be a fee to take out a loan on your 401(k), and you will be charged interest. The good thing about the interest, though, is that you pay yourself back because the money goes into your account.
If you leave the company before repaying a loan, you may have 60 to 90 days to pay it back, or the funds are considered a taxable distribution.
Making an early 401(k) withdrawal outside of a loan, or an early distribution, can cost you. You pay taxes on the amount you withdraw plus a 10% early withdrawal fee. There are some exceptions to the early-withdrawal penalty, so talk to your employer’s plan administrator if you need the money.
Your company may contribute to your 401(k) account. The company often matches what you put in — 50% of what you contribute, for example, up to 6% of your pay. Some companies add to your account even if you don’t contribute, while others give you company stock. You may also have to work for the company for a certain amount of time before their contributions are vested. Check with your plan administrator to find out what your employer’s contribution policy is.
Your 401(k) plan includes a choice of funds. You can decide how to allocate your savings by determining which funds to invest in and what percentage goes to each fund. If you don’t make a custom selection, your company may have a default setup for you.
You may be able to choose from funds such as:
- Money market
- International stock
- Domestic stock
- Domestic bonds
- Low-cost index
You may also be able to select target-date funds. These funds usually change from aggressive, stock-heavy to conservative, bond-heavy funds as you reach your target retirement date.
The investment fees you pay usually range from 0.5% to 2% of your plan’s assets. The amount you pay depends on the size of your plan, the provider and the number of participating employees. In addition to investment fees, you may pay administrative fees. It’s essential to talk to your plan’s administrator to understand what charges you are paying and what options you have to lower them.
When you leave a company, you typically have four options for your 401(k):
- Retain the money in your account
- Roll the money into an IRA
- Move the money into your new employer’s 401(k)
- Take a lump-sum distribution
To avoid paying taxes, keep your funds in a tax-sheltered account by rolling it directly into another 401(k) or IRA. If the company cuts you a check for your money, it will withhold 20% in taxes. Money left outside of a retirement account becomes taxable after 60 days.
Whether you’re just beginning your career or getting ready to retire, investing in a 401(k) is an excellent way to prepare for retirement. It helps you save money faster while taking advantage of company contributions. Retirement will be here before you know it — make sure you’re prepared.