401(k)s are a type of savings plan designed to help folks receive tax breaks on money saved for retirement. These plans are typically offered to employees by employers. 401(k)s are a great option for retirement savings because deposits can be setup to automatically take place when your paycheck is cleared. The type of tax break varies by plan, but they can occur when the money is withdrawn for retirement, or when the contributions are being made.
What if my Employer Doesn’t Offer a 401(k)?
It’s true. Not all employers will offer a 401(k) plan. But the good news is that you do have other options. For example, you could invest in an individual retirement account, or an IRA. IRAs offer a wider range of investment options while generally having lower fees when compared to 401(k)s. However, there are tighter restrictions on how much can be deposited, especially for those who earn more money.
Employer Match
One of the biggest perks to a 401(k) plan is that many employers offer to match what employees pay into the account, up to a certain percentage. This is essentially free money being contributed into your 401(k) account. It’s almost universally accepted that if your employer offers a 401(k) with any sort of match, then this is the savings plan you should sign up for and pay into.
Pretax Contributions
With a traditional 401(k) plan, your contributions are withdrawn from your paycheck and added to your plan before it is taxed. This effectively maximizes the money you contribute.
Lower Your Income Taxes with Your Contributions
The pre-taxed money that you add to your 401(k) can potentially lower your annual taxable income. For example, if you make $50,000 a year and you contribute $5,000 into your 401(k) plan. You’ll only owe taxes on $45,000 rather than $50,000, essentially protecting $5,000 from taxation.
Taxes on the Money in Your Account
Technically the money in your account is tax deferred. This means that as the money in your account grows, it’s protection from taxation remains in place until money is withdrawn. This includes money gained form interest or other investments. Taxes are to be paid on money withdrawn.
Benefits of a Roth IRA
One of the primary benefits of a Roth IRA is that the money contributed into the account has already been taxed. This means that you will not have to pay taxes on them again when it is time to begin withdrawing.
Changing Jobs
Should you choose to leave an employer with whom you have an established 401(k) plan, you will have the option to roll your plan over into your new employer’s 401(k) plan. You will also have the option to convert the money into an IRA fund if it suites you better.
Source: https://www.nerdwallet.com/blog/investing/what-is-a-401k/
