One of the most important aspects of personal finance is creating a strong financial cushion for the future. As we juggle our day-to-day financial responsibilities, planning for the long-term AKA retirement can often take the back seat. However, taking those steps to save for the future can help us reach our financial goals sooner than later. A quick and easy way to build a nest-egg for retirement is through a 401K plan.
The 401K lowdown
A 401K is an investment account offered by employers that allows you to invest your pre-tax income. This means that the money that is put into your 401K is not taxable. While the 401K is an investment account, it does not mean that it is an investment in itself but a medium that carries various investment options for you to choose from.
Saving money in your 401K account is incredibly straightforward. Once your account is set up, you will need to decide what percentage of your paycheck you want to contribute to the account. The employer automatically deducts this amount from your paycheck each month. This allows you to save money without actually putting any thought into it!
Your employer can match contributions
A primary benefit of your 401K plan is the matching program that many employers offer. This means that that your employer will contribute the same amount of money you decide to put into the account. For instance, your employer may match 5 percent of your salary. This means that they will match your contribution to the account until the value reaches 5 percent of your income. It would be wise to max out your contributions to your 401K account to take full advantage of this benefit.
Choose your investments
The great thing about your 401K plan, unlike regular saving accounts, is that you get to invest the money in your account. The 401K is like a basket that holds a variety of investment options that you can choose to allocate your funds to. However, it is important to assess your risk appetite when choosing assets to invest in. Younger people have a greater threshold for risk, allowing them to invest in a variety of stocks. However, as you near retirement, it would be better to invest in safer assets like bonds that are not impacted by market volatility. Some 401K investment options also offer target-date funds that mix up the assets in your investment portfolio as you age.
What happens if I switch jobs?
No worries! Your 401K goes with you. Before you switch jobs, it is recommended that you do your research on the best way to roll-over your 401K to your new employer. Many people consider cashing-out their 401K but this can result in some financial losses. Not only do you need to pay taxes on the money in the account but you also need to pay a 10 percent penalty. Hence, use this option as a last resort!
So when can I cash out?
The distribution of the funds in your 401K can vary by person. As a general rule, you can access the money in your account at the age of 59.5 and by law, you are required to take minimum payments from the account by the age of 70.5 (unless you are employed). At this time, you will pay taxes on the distributions and income gains.
The 401K is the perfect way to start saving for the long-term and can help you get closer to the financial future you dream of. If you’re not already a part of your company’s 401K plan, talk to your employer to learn more about what is offered through their program.