ABCs of 401(k)s: A Quick Guide To Understanding Your 401(k)

Whether you are still actively working or have retired and have not yet converted your 401k to an IRA, you own one of your most valuable retirement planning vehicles available. From the tax-deferred growth and up-front tax deduction to the benefits you received from dollar-cost-averaging into your 401(k) plan, you have grown a critical component in your retirement tool kit.

Some Basics to make sure You are getting the most from your 401k:

Why should you own a 401(k) Plan

Your 401(k) plan enables you to utilize dollar-cost-averaging (a financial tool that consists of regular investments that will allow you to buy more when an investment is cheap and buy less when it is expensive) and take advantage of tax-deferred growth. With many pension plans disappearing the 401k along with Social Security, is becoming essential to a comfortable retirement.

Unfortunately, the only way to invest in a 401(k) Plan is through your company

You can only participate in a 401(k) plan if your employer has one available to you. Unfortunately, you cannot set up a 401(k) plan on your own. (However, if a 401k is not available to you but you are still employed, you may establish an Individual Retirement Account (IRA) privately. If you’re self-employed, you’ll have other terrific retirement planning options as well.)

The first reason 401(k)’s work hard for you

Every regular 401(k) contribution immediately reduces your taxable income. For example, an individual in the 28% tax bracket who makes a $200 contribution to her 401(k) plan will immediately save $56 in taxes. (28% x $200). Although their 401(k) account grows by the full amount of their $200 401(k) contribution, their paycheck only goes down by $144!

The Next Reason 401(k)’s work hard for you

Since the money in your 401(k) plan grows tax-deferred, you do not pay taxes on the earnings in the account. You won’t have to pay taxes on the growth until you take your money out of the 401(k) plan, which would ideally be during retirement.

How to Invest in your 401(k)oney

Investing your 401(k) money is critical to its long-term growth. The younger you are, the more aggressive you can be, because you have time to ride out the ups and downs of the market. As you near or enter retirement, you should consider becoming more conservative to reflect the reality that you may be needing that money in the not too distant future.

Required Distributions from 401(k) Plans

In most cases, you must begin to take money out of your 401(k) plan starting with the year after you reach 70 1/2. The required minimum distribution amount is determined by the Internal Revenue Service and is based on your life expectancy.

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