Private sector employees can invest for retirement with a 401(k) plan
A retirement plan may be one of the most valuable benefits of employment. Used effectively, it can deliver a long-term impact on your financial well-being. See how a retirement plan works and learn about the power you have to control your financial future.
In general, a 401(k) is a retirement account that your employer sets up for you. When you enroll, you decide to put a percentage of each paycheck into the account. These contributions are placed into investments that you’ve selected based on your retirement goals and risk tolerance. When you retire, the money you have in the account is available to support your living expenses.
401(k) contributions are tax-deferred
Your 401(k) contributions are deducted right from your paycheck and go directly into your account before taxes are withheld. So, if your salary is $50,000 a year and you contribute $3,000 to your 401(k), only $47,000 will be considered compensation for income tax purposes instead of $50,000.
When you withdraw money from your account in retirement, it will be subject to ordinary income taxes. But since you'll be retired, you'll possibly be in a lower tax bracket.
Consider taking full advantage of the tax-deferral by contributing the maximum amount allowed by the plan. Check with your human resources department for limits and details. Please keep in mind that all investing involves market risk, including the possible loss of principal.
You may get matching contributions from your employer
Your employer may match a certain percentage of your 401(k) contributions – most do. For example, if your company matches 0.5% for every 1% you contribute up to 6%, that translates into an extra 3% in your account if you contribute 6% or more.
With the example above, your $3,000 contribution plus your employer’s match would add $4,500 to your 401(k). (The plan may have rules when the matching contribution is vested. See your employer for details.)
You can avoid an additional 10% early withdrawal tax by leaving your money in the 401(k) plan
Because 401(k)s are retirement savings plans designed to help you save for retirement, any money you take out early will be subject to an additional 10% early withdrawal tax unless an exception applies. First, any amounts withdrawn will be subject to ordinary income tax. Second, unless an exception applies, money taken prior to age 59 1/2 will be subject to an additional 10% early withdrawal tax. Finally, if you do not roll this money over, it will be subject to mandatory 20% federal tax withholding.