A 401(k) is a type of retirement account offered by many employers. If you participate in a 401(k), you determine how much of each of your paychecks gets diverted into your 401(k). A 401(k) has advantages over traditional investment accounts. Since a 401(k) is “tax deferred,” you pay no income tax on your 401(k) contributions. When you withdraw funds from the account you will pay income tax on what you withdraw, but since 401(k)s defer taxes far into the future, your investments will grow tax free, likely resulting in greater returns. How To Retire Strong Compounding Manage Credit Save And Invest IRA 401(k)

401(k) FAQ
Q: What is a 401(k)?

A: A 401(k) is a type of retirement account offered by many employers. If you participate in a 401(k), part of each paycheck will go into the account. There is an upper limit on how much of your wages you can contribute to your 401(k). Some employers match a portion of your wages. Take advantage of this free-money-giveaway. You should know that there are penalties for taking your money out of the 401(k) before you reach the age of 59 ½. You will be taxed at the time you remove funds from your 401(k). If you need access to the assets in your 401(k) you may be able to borrow against them without incurring the penalty for early withdrawal. But like any loan, you will incur interest charges and you have to pay it back.

Q: Why should I put my hard earned money into a 401(k)?

A: 401(k)’s offer two main advantages over simply putting money in a regular investment account. First, you don’t pay federal income tax on your 401(k) contributions. And second—unlike a regular investment account, you don’t pay taxes on any gains you receive while your investments are held in the 401(k). Note that in a regular investment account, you may have to pay taxes each year as your investments increase in value. Over time this yearly taxation erodes the value of your retirement savings. The 401(k) offers a one time tax event at the time you take funds out.

Q: I have signed up for a 401(k) at work. Are there other retirement accounts I can take advantage of?

A: Your 401(k) can be one of many retirement income sources. If you have extra funds to invest, you should also think of opening an IRA. After contributing the MAXIMUM amounts possible to your 401(k) and IRA, If you STILL have additional funds available to invest, consider opening an “individual investment account” and buy a diversified portfolio of low-fee no-load mutual funds. Note that you can have your IRA account at the same brokerage as you have your individual investment account.

Q: Why shouldn’t I just open an investment account first, and then if I have leftover savings to invest, place them into a 401(k) or IRA?

A: From a retirement planning perspective, you should not have a traditional investment account unless you have maxed out your IRA and 401(k) contributions. Why? Traditional investment accounts do not offer the tax advantages that IRA’s and 401(k)’s offer. Over time these advantages become significant and can make a real difference in your retirement assets. By FIRST placing assets in the 401(k) and IRA accounts, you will be sure to maximize these benefits for yourself. And if you have the means, absolutely open a traditional investment account if you so desire.

Q: Is there an upper limit on how much I can contribute to my 401(k)?

A: Yes. In 2006, you can contribute a maximum of $15,000 to your 401(k).

Q: My employer matches a percentage of my wages. Should I reduce the amount I personally contribute since the employer will make up the difference?

A: If at all possible, take advantage of this free-money-giveaway by contributing the maximum legal amount you can contribute. Here’s an example. Let’s say Person A and Person B both make $30,000 per year. The employer has a 6% match. Each year Person A contributes 6% ($1800) of his salary to his 401(k). The employer matches all 6% of Person A’s contributions. Person B contributes 3% ($900). At the end of the year Person A’s total 401(k) contributions will be $3600 or 12% of his salary. Person B’s contributions will only amount to $1800 or 6% of his salary. Person A only personally contributed $900 more than Person B but because he maximized his employer’s matching program, his account increased by $1800!!!

Q: I have been contributing to my 401(k) but something has come up and I need to get to the money NOW!!! Can I do this?

A: Yes. But if you are less than 59 ½ years old, you may incur a 10% penalty for early withdrawal. Check with your employer’s plan administrator for rules specific to your employer’s 401(k) plan. There are a few options. 1) You may be able to borrow money from your 401(k). 2) You may be able to simply withdraw money from the account. Whether or not there will be penalties assessed for early withdrawal depends on your employer’s plan and the reason you need the money.

Q: I have signed up for a 401(k) at work. Are there other retirement accounts I can take advantage of?

A: Your 401(k) can be one of many retirement income sources. If you have extra funds to invest, you should also think of opening an IRA. After contributing the MAXIMUM amounts possible to your 401(k) and IRA, If you STILL have additional funds available to invest, consider opening an “individual investment account” and buy a diversified portfolio of low-fee no-load mutual funds. Note that you can have your IRA account at the same brokerage as you have your individual investment account.

This website is for informational purposes only and does not provide or intend to provide legal or financial adivce. Please consult an attorney, accountant, and or financial planning professional for financial and legal advice. Copyright 2006. All rights reserved.