You’ve got a real job now? Congratulations and welcome to adulthood. While your previous jobs may have skimped on the benefits, you’re in the big leagues now. This means a 401 (k) plan, among other things. But what is this plan, and how does it work?
A 401 (k) is a plan for retirement savings sponsored by your employer. You can save and invest a part of your paycheck before taxes are taken out. The plan is named after the part of the tax code that governs it. With a 401 (k), you control how your money is invested. You decide how much you want to contribute, and your employer will put the money in to your account on your behalf. From then on, the same percentage goes into your account every paycheck which will be slightly smaller.
Your employer serves as the sponsor for a 401(k), but that doesn’t mean it has to have anything to do with investing the money. A mutual fund company or brokerage firm will administer the plan and its investments. Your employer sends your payroll deductions directly to the company managing your plan, but you get to decide how you want to invest it. You can choose from the investment choices that the plan offers, which are usually mutual funds. When investing in long-term goals like retirement, you probably want to invest mostly in stocks, which have the best changes of generating returns that beat inflation.
How much can you invest in your 401 (k)? Because plans have valuable tax breaks, it’s probably wise to invest all you can. In 2018, if you are under 50 years old, you can contribute a maximum of $18,500. If you’re older than 50, you can invest a total of $24,000. The limits change every year adjusted for inflation.
Many 401 (k) plans come with an additional bonus, a matching contribution from your company. The match can be up to 50 cents per dollar or more, up to a set maximum. This effectively increases your income without increasing your tax bill, since you won’t pay taxes on matching contributions until you withdraw them from your retirement. When do you have to start taking money out? You can leave it in there for a long while, but when you turn 70½, you have to take required minimum withdrawals.
A 401 (k) is a powerful tool to save for retirement. Properly invested, the money in such a plan can make a positive impact on your retirement.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any options are those of Billy Peterson and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete.