How Does A 401k Work?
How does a 401k work? A 401k is a tax deferred retirement plan offered by employers in the United States to their employees.
Only an employer can sponsor a 401k for their employees. The employess decides how much of their monthly pay check they wish to deposit into this plan. This is based on what they can afford and IRS regulations that limit the amounts of contribution.
This amount is then deducted from the pay check (pre-tax) and deposited into the plan. Quite often the employer will match the contribution up to a certain percentage, although they are not required to do so.
As the contribution is deducted from the pre-tax pay and the tax on the contribution is deferred, meaning tax is payed at the time of withdrawal, it also lowers the present tax liability of the saver.
It is the employers responsibility to administer the plan in accordance with laws and regulations, they will also determine who is eligible for the plan, how much they can contribute, whether those contributions will be matched an so on. This makes the 401(k) a very easy way to begin preparing for retirement, it really requires very little effort on behalf of the individual.
If you currently have no planned retirement and your company offers a 401k it is a good idea to seriously consider it. The sooner you start preparing for retirement the more comfortable you will be. Keep in mind you may have 30 or more years where you need to provide for yourself, so the sooner you start planning for this the better. An early start is one of the keys to success.
does have some drawbacks, it is not a savings account and accessing your money in a hurry could be difficult or expensive. Some plans do allow you to access your funds in the event of hardship or borrow money against it, but check the details of your individual plan for the rules on this.
Investment For Retirement
What Is A Traditional IRA?
What Is A Roth IRA?