As the topic said.
Thanks :smack:
Consulting the oracle at google reveals:
It’s an investment account to which you can contribute a portion of your paycheck. It is designed to encourage savings for retirement, and therefore has very good tax breaks, as long as you don’t withdraw any money until age 62.5. (I think.) The 401(k) refers to the section of the IRS code which regulates such accounts.
The quick summary on 401(k) plans is that they let you take some money that you earned and place it in a retirement account, and not have it count as taxable income when you put it in the account. Instead, the money (hopefully) increases in value and/or earns interest for many years, and then you pay taxes on it when you take it out after you retire. Almost all companies now have some sort of 401(k) plan for their employees. There was quite a bit of controversy surrounding them during the recent corporate scandals because it turned out that the plans for some companies such as Enron were managed to benefit the company at the expense of the employees.
And just as 401K is reference to a specific section in the Internal Revenue Code, there are a number of other similar plans for non-corporate workplaces that have their own section number identifier.
What he said. As an employee of a county-owned hospital, for instance, our corresponding retirement plan is a 403(b). My wife – a teacher – used a plan under the same section.
RR
The best thing about them for us “little people” is that contributions are taked out in pre-tax dollars. So if you earned $30,000 a year but contribute 10% ($3000) to your 401(k), the you only “earned” $27,000 that year for tax purposes as far as the IRS in concerned.
Also, in some companies the the company will “match” what the employee contributes to the plan. For example, where I work if I put 6% or more into my 401(k) my company puts in 3% additional. Not much but, hey, who turns down money?
As was stated the money you put into the plan is pre-tax but only up to a certain point. (Somewhere around $10k IIRC.) You can put more than that into the plan but you don’t get the tax advantage from it.
Rex: << So if you earned $30,000 a year but contribute 10% ($3000) to your 401(k), the you only “earned” $27,000 that year for tax purposes as far as the IRS in concerned. >>
There are two major tax breaks for putting your own money into a 401(k):
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The contribution that you make (the $3000, to use Rex’s example) is not taxed. However, when you reach (let’s say) age 67 and start taking out the money, then it WILL be taxed. The idea is that, at that point, you’ll have less total income (being retired), and so the tax rate will be lower. Thus, not only is the tax deferred, but the rate is (presumably) lower.
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The earnings on the $3000 is not taxed until you take money out of the account, presumably at retirement. This is a substantial savings, and the earnings will compound much faster than a comparable amount in a taxable savings account. Thus, you’ll wind up with more money at retirement than you would have if you had just invested the money in a taxable investment.
Obviously, if your company matches your contribution, that’s an additional plus.
Most 401(k) plans allow you to choose how to invest your money. The plan offers several different funds, and you can allocate your money amongst them as you choose – high-risk, low-risk, etc. Many large companies allow you to invest your 401(k) assets in company stock, and they tout this as a wonderful thing. They also often put the company match into the company’s own stock, and you have no control over that investment. They tout this as a marvellous way of investing in your employer and reaping the benefits of etc etc. This was the Enron problem. I’ve always thought it was a really stupid idea, the technical term is “putting all your eggs in one basket.” If the company goes belly-up, you’re not only out of a job, you’ve also lost your retirement savings.