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401k

What is a 401(k)?

Saving into your 401(K), however small, always adds up.

A 401(k) offers one of the simplest ways for people to start a savings plan for retirement and is a must have for anyone’s financial portfolio. A 401(k) is one of the first steps people take towards thinking about their financial future and the bottom line is you should have one.

Your monthly contribution is deducted from your salary before taxes are taken out. This is a crucial benefit of taking out a plan and one of three great reasons why everyone should have one.

1. Pay less Tax!

Let’s say, for easy math, that your monthly salary is $1,000 before tax. If you paid 10% into your 401(k) ($100) you would now only be taxed on the remaining $900 of your salary. You get to have 10% of your salary every month dodge the tax man and go straight into savings.

2. Free money! (no, seriously)

The second great reason is many companies will make, or even match, your contribution into your plan every month, for as long as you continue to. A typical match is 50 cents from an employer for every dollar saved by you. So if you can save save 10% to your 401(k) with you employer matching, your essentially giving yourself a 5% pay rise!

*Ask your employer about their 401(k) plans and policies because if you and your employer are not contributing to a plan, you’re simply giving away free money.

3. Tax deffered growth.

The money you save benefits from tax-deferred growth, which lets your money compound more quickly than it would if it were taxed yearly. If you save $100 per month tax-deferred, earning 8 percent for 10 years, you could accumulate $18,417. However, that same $100, after tax, would mean saving only $75 per month. Your 8 percent earnings would also be taxed, reducing them to only 6 percent! The end result for your retirement is that your taxable savings over 10 years would accumulate to only $12,352.

 

Maximum contribution. 

Sadly there are limits on how much you may contribute to your plan each year, although the federal limit on annual pre-tax 401(k) contributions is on the rise. For 2012, the maximum contribution is $17,000, or $22,500 if you’re 50 or older.

 

Warning!

 

Taking any of your money out of your plan before you retire is very expensive! Any loans must be repaid with after-tax money plus interest. With few exceptions, withdrawing your money before age 59-1/2 will require you to pay income taxes plus a 10% penalty. On top of all of this, you’re adding lost time for compounding, which will substantially shrink your financial future. Basically, just don’t do it. :)

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What if i change my job?

When you change jobs, you essentially have three choices: leave your money where it is, roll it over into another 401(k) or into a new IRA (more on IRAs Here), or cash out. If your plan’s account balance is less than $5,000, you may well find your employer insists you take it out of the plan.

Remember, cashing out is like slapping yourself in the face financially. Even small amounts invested can grow large over time with tax-deferred compounding. You’re always better off rolling the money into another retirement plan.

 

No matter what your financial situation, if a 401(k) is available to you, take it.

 

ThirtySomething.

 

 

Image courtesy of sscreations / FreeDigitalPhotos.net

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