401(k) retirement plans were first introduced by Congress in 1978. The name comes from the section (401) and paragraph(k) of the Internal Revenue Code. The retirement plans were created to encourage Americans to save more for retirement.
Here are some tips and information to take full advantage of the benefits of a 401(k):
401(k) plans are part of retirement plans known as “defined contribution” plans. A defined contribution plan is defined by the employee or the employer. To be eligible, you must work for a company that offers one. There are similar plans such as the 403b (offered by schools and tax-exempt organizations) and the 457 Plan (offered by the government).
There are three great benefits of these retirement plans:
• They reduce your taxable income, since contributions are made before taxes.
• Money in the account grows tax-deferred, so there is more money to compound and grow than if you were taxed yearly.
• Many employers match contributions, essentially giving you free money!
It is important to join your company 401(k) plan as soon as you are eligible. To get the employer match, some employers require employees to contribute a certain amount. Find out what it is to take advantage of this great benefit. A typical employer offers 50 cents for every dollar you contribute up to 6 percent of your salary. This means if you put in the full amount at 6 percent, you will get 3 percent from the employer, which is a 9 percent contribution to your 401(k).
In addition to starting as early as you can, it is also important to determine how much you need to contribute to reach your retirement goals. Experts say that if an employee works and saves for 30 years and for retirement will only have their 401(k) and Social Security, the employee will need to contribute 13 to 15 percent of their income every year. If the free matching from the employer is 3 percent, the employee can contribute 10 percent to get the total contribution of 13 percent.
If you can’t make a contribution that large, start with an amount to at least get the free matching and raise the amount every year in line with your pay raise.
Some plans have a feature called “contribution escalator” that automatically increases your contributions by a certain amount on a future date you set. The maximum contribution to a 401(k) plan in 2012 can be as much as $17,000 or $22,500 if you’re 50 or older. But the plan offered by your employer may restrict you to a lesser contribution. This federal limit on the 401(k) plan is generally raised every year.
When setting up your 401(k) account, make sure your account is well diversified, and have a proper allocation of stock, bonds, cash and alternative investments based on your risk tolerance and time horizon. Creating a good portfolio can make a huge difference in the long run.
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