Understanding the Basics of a 401(k) Plan

What exactly is a 401(k) plan?

Think tax-deferred golden eggs

A 401(k) plan is a type of retirement plan that is offered as a voluntary investment opportunity for employees. Individual employees determine a percentage of the wages that they’d like to invest before taxes are taken out. The allowable percentage will vary from employer to employer, and the federal government places a maximum on how much can be invested annually. This maximum amount fluctuates, however, according to the consumer price index and inflation, so it is not necessarily the same each year.

Often, employers will match their employee’s contributions to a 401(k) plan either in whole or in part. The contributions made by the employer and the employee, however, are not immediately taxed, nor is the interest that the investment accrues. However, when funds are withdrawn for retirement or other needs, they are taxed at that time.

What happens to money in a 401(k) plan?

Most who invest in a 401(k) plan have the option of applying their money to many different investment vehicles, such as mutual funds, stocks and other investments. It is important, however, for employees to understand all potential risks and benefits associated with these investments and make a decision based upon this information. It is always a good idea to sit down with a qualified financial planner to help make this determination.

What if I need to withdraw money before I retire?

Money can be withdrawn from a 401(k) plan before retirement for emergency cash or for other reasons. Generally, it is a good idea to refrain from doing so, however, unless it is absolutely necessary. The reason for this is that money that is withdrawn is subject to taxation and the money will no longer earn interest or other gains once it is removed from the account. However, some people find themselves in a position where they need money right away. In this case, it is good to discuss withdrawing cash from a 401(k) plan with a financial planner or an accountant to be sure about what will be owed on the money and to discuss any other pertinent details about withdrawing it before retirement.

Can I change my mind about how to invest the money in my 401(k) plan?

Most often, this answer is yes. Unless a person is invested in their company’s stock program, money from a 401(k) plan can be channeled to another investment. Usually, a person will choose to do this when their financial goals have changed or when they are unhappy with the performance of the investment vehicles they have chosen. At any rate, most plans allow a person to make changes by making a simple phone call. In some cases, changes can be made daily, while others only allow for changes at certain intervals. This is another reason why it is advisable to sit down with a financial planner before investing in order to know what your options are should you change your mind.

Invest now for a bright future

Understanding what a 401(k) plan is and how it operates increases a person’s wealth education. With a sound financial plan, that includes retirement planning and investing, people can grow their wealth and make their money work for them. No matter a person’s income level or debt situation, everyone should be thinking forward and learning what opportunities exist for investing in a bright financial future.

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