You just got hired! Now you are sitting there going through your new employee orientation packet, you are getting excited about all the benefits you are now entitled too. Medical, dental, and paid vacation was all you were hoping for (or really knew about) but included is an option for a 401(k) plan and you aren’t really sure what that is about.
A 401(k) plan is an employer sponsored savings plan or defined contribution plan that allows workers to save for their retirement. Workers can have money from their income diverted into an investment account. That money will be deferred from income taxes and earns interest until it is ultimately withdrawn.
A great benefit of a 401(k) is if you are on the cusp of income taxes, the maximum tax free deferred can push you into the lower tax bracket, thus reducing your tax bill.
Your employer sets up the 401(k) program (the most common are participant-directed plans) and an employee must opt in. However, the choices and options offered on 401(k) plans from company to company vary greatly. Some companies offer additional matching contributions to an employee’s investments (i.e. a dollar for dollar matching up to $2000) while other don’t offer any additional cash incentives at all. You can establish a goal for your 401(k) savings with a retirement calculator.
Employers choose a third party investment firm to manage the 401(k) plans for their employees. They usually offer employees a mix of mutual funds for them to choose from and diversify their 401(k) investments.
There are severe tax penalties for early withdrawal of 401(k) monies to deter people from touching the funds until their actual retirement kicks in. When leaving a company, it is imperative that an employee speaks to a financial professional and find out how to “roll-over” their 401(k) plans. Many individuals choose to cut all ties with their former employers and there are many options for properly reinvesting the retirement money so an individual does not have to immediately pay taxes or penalties.