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401(k) Plans

What is 401(k)?

A 401(k) is a retirement savings plan offered to millions of Americans by their employers. When you sign up for a 401(k) through your company, you agree to put a portion of your paycheck into the account. Contributions are automatically deducted from the employee's paycheck.

The 401(k) retirement plan was passed by the US Congress under Section 401(k) in the Internal Revenue Code to encourage Americans to save for their retirement. The money in your 401(k) account is invested in mutual funds, bonds, and other investment assets. However, the employee gets to choose the investment options that they prefer. The capital gains in your 401(k) grow exponentially due to compound interest. 

A 401(k) is a tax-advantaged retirement plan. Depending on your chosen plan, the tax break comes either when contributing the money to your account or withdrawing during retirement.

401(k) Considerations

If your employer is offering a 401(k) plan, these considerations can help you maximize the potential benefits of this retirement plan.

Traditional or Roth?
You will have an option of contributing to a traditional 401(K), Roth 401(k), or both.

If you choose to contribute to the traditional 401(k), your contributions will be deducted from your gross income. This means the money comes from your paycheck before income taxes are deducted. As a result, your taxable income is reduced by the amount of contribution counted as tax deductions. No taxes apply to the 401(k) contributions or capital gains until you withdraw, mostly in retirement.

For Roth 401(k) plans, contributions are deducted from your after-tax income. As a result, there will be no tax deductions. When you withdraw the money during retirement, there will be no additional taxes. However, some employers don't have a Roth account option.

Basic Financial Planning Principles
One of the basic financial planning principles you should understand is the time value of money. Working with a financial advisor will help you develop a strategy to help your money grow. Starting to save early little by little is better than waiting to save more in the future.

Contributing to a 401(k) plan gives you a good start for your long-term financial security. Your money in the 401(k) plan plus the capital gains from the investments grows on a tax-deferred basis. So even small contributions, if put in a suitable investment vehicle, can grow to a substantial amount over time. The earlier you start, the greater chance you have of building enough savings to retire comfortably.

Contributions Limit
The federal government has set the limit of your contribution to your 401(k) annually. The annual contribution in 2024 are $23,000, and if over the age of 50, limit is $30,500 ($7,500 catch up). 

Vesting Rules
Any money you contribute to a 401(k) retirement plan and capital gains to the contributions belong to you. However, the amount that your employer contributes on your behalf belongs to your employer until it is vested. Vesting gives you legal rights to your account and is determined by how long you stay in the job.

401(k) Pros and Cons

401(k) Pros and Cons

Probably you are asking, should I get a 401(k) or is 401(k) worth it? To help you answer these questions, you should understand the pros and cons of the 401(k) plan.

Some of the benefits include:

  • Income tax advantages include enjoying tax-deferred growth and investing with pretax money until distribution.
    High contribution limits
  • Access to loans in case of an emergency or financial crisis
  • Employer matching
  • Contributions reduce taxable income
  • Enjoy federal legal protection of the retirement plan

Cons of a 401(k) retirement plan are:

  • Early withdrawal penalties of 10% of the amount if you withdraw before you reach 501/2 years.
  • Limited investment options
  • Higher account fees due to administrative responsibilities required

Frequently Asked Questions

Is it better to have an IRA or 401k?
With so many similarities, many are confused about whether to choose an IRA or a 401(k). If you can contribute to both, you will reap each offer's full benefits. Even though this is possible, many cannot afford it. However, if your employer offers a 401(k) with matching contributions, you will benefit more when you put enough funds in your 401(k) and enjoy the maximum match.

On the other hand, if there is no 401(k) match, you can contribute up to an IRA at first to access a large selection of investments. You can later fund your 401(k) account after contributing up to the IRA limit.

Can you lose money in a 401k?
While 401(k) is a good retirement plan, it is not perfect. Like other types of investments, there are risks involved. Although the 401(k) retirement plan is designed to offer security against losses, it is not a new thing to see your account balance drop occasionally. Some of the reasons for the loss of money include:

  • Being unable to pay back a 401(k) loan
  • When you cash out your investment when there is a downturn
  • When you quit your job before getting the employer match

What are the disadvantages of a 401k?
While a 401(k) plan comes with benefits that help in long-term saving, it has some drawbacks, which include:

  • High fees
  • Limited investment opportunities
  • Tax implications for early withdrawals
  • Not easy to access your funds early
  • Non-existent or small 401(k) match in some companies

Contact Everest Financial, Inc. Today

Access to different investment options is just one part of a successful 401(k) retirement plan. As a contributor, you need to know how to maximize the plan's potential. A financial advisor will advise you on the right investment options and develop a plan to address your financial concerns. At Everest Financial, we help you through every life milestone by offering honest advice and making you our top priority. Contact us today!

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