How to Make the Most of Your 401(k) Plan

If you are one of the millions of people who are eligible to participate in an employer-sponsored 401(k) plan, do it! There are numerous benefits–both present and future–that are available to you for contributing to this type of retirement plan.

First Step: Contribute

Although it might sound obvious, in order to make the most of your 401(k) plan, you must actually participate! There are millions of eligible employees nationwide who do not contribute to their 401(k) plans and they are missing out on a great deal of tax and financial benefits. So unless you are drowning in debt and need every dollar you make to go towards bills, start socking away some funds for your future.

If you are already participating in your employer 401(k) plan, see if you can increase the amount you are contributing each month or year. In 2010, the maximum amount you can contribute is $16,500. If you are age 50 or over, you are eligible to make an additional “catch-up” contribution of $5,500.

The sooner you start, the more you will contribute over time. Invested wisely, you could end up with a considerable amount of retirement funds in the future.

Avoiding the Tax Man

One of the biggest present benefits to participating in your 401(k) plan is the contribution tax advantages. Each dollar you contribute to your traditional 401(k) plan is a dollar that is taken off the top of your taxable income for the year.

For example, if you earn $50,000 and you contribute 10 percent of your income to your 401(k), or $5,000, you are actually lowering your taxable income amount to $45,000. So, if you are in the 15 percent tax bracket, then you have essentially just saved yourself $750.

Free Money!

Many employers offer a matching contribution to employees who participate in their 401(k) plans. You should consider contributing at least as much as you need in order to maximize your employer’s match. This amount could actually be considered to be a raise. The bottom line here is that this is free money!

Even if your employer’s matching amount only comes to a few hundred dollars per year, over time this amount could add up to thousands of additional dollars for your retirement.

Be Patient and Consistent

With all of the turmoil in the stock market over the past few years, it is easy to get scared and discouraged when you see the losses on your quarterly 401(k) statement. However, although easier said than done, this is the perfect time to KEEP contributing, or even raise your contribution thanks to the benefits of dollar cost averaging. There are many good quality stocks and mutual funds available now at bargain prices. Wouldn’t it make sense to stock up when everything is on sale?

Don’t Dip Into Your Funds

Although emergencies happen, the last place you want to seek funds is from your 401(k). Dipping into your account and withdrawing even a small amount can have dire consequences to your overall funds at retirement. In addition, you will likely be liable for taxes and penalties on the funds withdrawn.

You should consider your 401(k) your long-term nest egg and only to be used for your retirement in the future. Removing any of it now could realistically cause a change in your future retirement lifestyle.

Take It With You

If you leave your current employer, then by all means, take your 401(k) with you. By doing so, this does not mean withdrawing the funds. If so, you will be responsible for taxes and penalties on the withdrawn amount. However, you can transfer the money tax and penalty free into a personal IRA account.

In most cases, you can even transfer the funds “in-kind,” meaning you can retain most or all of the current stocks and mutual funds you currently hold in your 401(k). The difference is that you can continue contributing to the portfolio as a personal IRA account where you have control over any future investments and decisions versus your former employer.

This guest post was written by Andy from Saving to Invest, a website that covers a range of money topics looking at wealth creation, retirement planning and tax strategies. See more and subscribe to get more personal finance topics delivered direct.