Situation

I will be starting a new job soon and will have the opportunity to participate in my employer’s 401(k) plan. What are the important things to consider?

Suggestion

Let’s start with the basics.

  • A 401(k) plan is a popular type of retirement plan where you defer a portion of your wages into a tax qualified account.
  • The amount deferred reduces your current taxable income and earnings on the funds accrue on a tax-deferred basis.
  • Employers usually match part of what the employees put into the plan. The employer match amount usually vests over a few years.
  • When you leave your employer, your money and the vested portion of the employer match goes with you. You can take it out and pay tax on it, transfer it to your new employer’s plan or roll it into an IRA without tax consequences. Most people roll it into an IRA.

There are only a few questions which you will need to answer.

  • Do you want to participate or not?

    The answer should be yes. Participating in a 401(k) plan is a great way to save money for retirement and build wealth.

  • How much of my wages should I defer and put into the plan?

    There are IRS limits on deferrals and plans vary. Most plans allow for up to a 6% deferral and many plans allow deferrals up to 10% or 15%. Many young employees start out with a modest (4% or 5%) deferral and then increase the percentage each year. If you can afford it, defer enough to that you can get the full employer match.

  • How should the funds be invested?

    Most plans offer several mutual fund investment options (equities, fixed income, money market fund or some combination). Each type of investment has certain risks that you should understand.

  • Younger people often allocate a larger portion of their funds to equity or stock funds as they have produced higher returns over time. However, if you are uncomfortable with the risks of stock investments, you may want to consider the other alternatives.

In any case, make sure to ask questions and be comfortable with your choices.

Summary

A 401(k) is a convenient and tax efficient way to save for retirement and build your wealth. Participate in the plan, contribute as much as you can afford and invest the funds based on your time horizon and risk tolerance.

 

 

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