HOW MUCH? - 401K

The basics of a 401K plan.


A 401K plan is a retirement plan established by employers which lets employees save a portion of their earnings, before taxes are taken out.

A 401K is funded with worker’s pre-tax dollars and employers contributions (if any). Both the growth of the funds, and the employers contributions are tax-deferred, which means you only pay taxes when the money is withdrawn. In that sense, 401Ks are similar to Individual Retirement Accounts (IRA), where the money cannot be withdrawn until the age of 59 and a half, except for special circumstances. However, most employers include an option of obtaining loans against 401K accounts.

Nowadays, a 401K is offered in place of a traditional pension. It can be a very powerful tool to make up the difference between your Social Security payment and the pre-retirement earnings.

401K contribution limits.

The plan allows each enrolled employee to contribute a certain amount of their salary up to the limits established by employers at the time the plan was set up. The details of those limits vary among employers.
The Internal Revenue Service (IRS), on the other hand, has its own limits. In 2005, it is $14,000 and in 2006, it will be $15,000. The IRS also allows catch up contributions to the 401K plan for persons who are 50 or older. The catch up contribution limits are as follows: 2005, $4,000 and 2006, $5,000.

401K main benefits.

- account balance grows quickly, because not only are the employer’s and employee’s contributions tax free, but the growth of the funds are also tax free.
- your contributions are tax free, which might put you in a lower tax bracket, essentially saving money on federal, and in most cases, state taxes.
- portability: when leaving an employer you can take the money with you and put it into the new employer plan or, roll it over to your Individual Retirement Account.
- you are in control of your money. It is up to you how and where the money is invested.

401k Retirement Investing
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- A 401K is usually set up as payroll deductions which make saving easy.
- you are able to invest in large managed funds that have high minimum investment requirements.
- most 401k plans have a loan option: you borrow from your own account with no penalties (or taxes), and pay it back to yourself, including the loan interest.

See also: 401k contribution, 401k investing, Roth IRA, interest rate

Related topics: 401K calculator, 401K fees




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