If your employer offers you a 401(k) plan but you don't know where to begin, you aren't alone. To get started, we are going to dive into what a 401(k) is and some tips and tricks to help you make the most of this retirement savings plan.
What Is A 401(k) Plan?
A 401(k) retirement plan is a tax deferred contribution plan provided by employers to their employees.1 The way it works is you decide how much you want deducted from your paycheck, up to a certain annual limit, and put into your 401(k) account each pay period. Your employer can also choose to match your contributions to encourage you to invest and save for retirement. Here's some key strategies to ensure that you are using your 401(k) to it's full advantage.
1. Match Your Employer
The biggest mistake you can make with your 401(k) is not matching your employer's contribution if your employer offers a match. Essentially, your employer's match is "free money" that your employer puts into your 401(k) based on your contribution. If you don't maximize that by contributing to your 401(k) you are missing a big opportunity to save and invest more for your retirement.
2. Increase The Amount You Are Investing
Slowly but surely you'll want to escalate the amount that you are investing in your 401(k) annually. If you stay at the same investment rate you won't reach your retirement goals as quickly. So, tell yourself that every year you are going to increase the amount that you are putting into your 401(k). Experts suggest saving 10% to 15% of your income for retirement. Although your employer may only match up to a certain percent, you may still be able to invest money on your own and have it be tax deferred depending on your employer's match. Sure, seeing more and more money come out of your paycheck and go towards your 401(k) each pay period may be hard to see, but you'll be thankful in the end since that money is matched by your employer and tax deferred.
3. Don't Withdraw Your Money Early
Taking money out of your 401(k) early can have significant tax impacts and withdrawal penalties. Except in certain circumstances, withdrawals made from your 401(k) will be taxed as additional income for the year and be assessed an additional 10% early withdrawal penalty. If the withdrawal is large enough, it can even push you into a different tax bracket. It’s best to wait until at least age 59 1/2, to avoid the 10% early withdrawal penalty; wait even longer if possible. The longer your money is invested, the more it can grow for you.
4. Learn About Your Company's Vesting Schedule
Most companies have a vesting schedule in which they put their contribution money into your 401(k) account after a certain amount of time. Once your account is fully vested, you own 100 percent of that money. It's extremely important to know how your company approaches their vesting schedule in case you were planning to leave your job. If you leave your job before your employers' contributions are vested, you'll lose their contributions to your 401(k). However, your personal contributions to your 401(k) will always be yours.
Last But Not Least
A 401(k) is a great retirement plan option if you use it to your advantage. Make sure you capitalize on the opportunity to have your employer match your contributions to ensure that you'll be on the right road to retirement.