Let’s say you have just started a new job, you sit down to fill out paperwork and you pick up the benefits folder and you read something about a 401k.
What is a 401K? In simple terms it is a financial plan that allows you to put money away for your retirement. Our parents called this a pension; this is an updated version of that. Your future happiness depends on your 401K and you should treat it very importantly, as you probably won’t be able to collect that much from social security and shouldn’t depend on it.
The way the 401k works is this: When you enroll, you commit to having a percentage of your compensation deducted from each pay check and deposited into a special account. You are then able to invest these finances in a variety of mutual funds. Your weekly contributions and earnings will continue to grow and a tax deffered basis which means you won’t be taxed on any of this money unless you withdraw money from your 401k.
As far as withdrawing money, you should think very seriously before ever considering doing so. You can take money out early but it will cost you dearly. Once you make a withdrawal, you are then taxed on the money. A more prudent way to do this would be to take out a loan against your 401k then paying that back plus interest. Keep in mind though; this should only be done in an emergency situation, not to finance a fancy vacation! If you are fortunate, your company will match all or part of your contributions to your 401k. This will allow the fund to grow a lot faster. For example let’s say your company matches twenty five percent of your contributions. This means for every hundred dollars you contribute they will contribute twenty five dollars. It’s kind of like free money.
Most companies will invest in the mutual funds for you, but some may offer you a choice in which funds you wish to invest in. If this is the case, it would not be a bad idea to run the plan by a competent financial advisor who should be more versed in the various mutual funds offered than you are. Always make informed financial decisions whenever possible.
If your company offers to do this, it is strongly advised that you take full advantage of it. Another benefit of 401k plans is that they are portable; meaning that if you leave a company you can take it with you. It will never stay at that company. A new employer should be able to roll your existing 401k into a new plan or into an IRA. With either scenario, you still won’t have to pay taxes on your money until you withdraw the funds.
Should you invest in a 401k? If you plan on living comfortably after you retire and having your financial needs met, it is absolutely essential that you invest in a 401k.