When it comes to saving for retirement, the 401(k) plan is the most widely-used employer retirement savings plan available. The majority of working Americans are able to participate in a 401(k) plan and many companies will provide a match on contributions the employee makes. Some companies have restrictions on how the money the company contributes can be invested and when it becomes available to you as an employee. However, you still can max out your contributions and build a large retirement nest egg.
Learn about your employer's 401(k) plan. You will want to know who is the plan provider, what investment options are available for your contributions and who can help you get enrolled as a plan participant. You will also want to know if your company will provide a match on your contributions, how much it is and when you will fully own the match dollars. For example, some companies require you to work for at least five years before the dollars they put into the 401(k) plan for you are considered "vested" (employee owned). After gathering all this information, you will now want to enroll in the plan.
Set your contribution rate. Most companies will take the contributions directly out of your paycheck at your request. You may choose to contribute a set dollar amount, such as $200 weekly or you can contribute a percentage or your income. The contributions will come out of your paycheck "pre-tax,” meaning the dollars going into the plan are not initially taxed as income. You will not have to pay income taxes on these dollars until you make withdrawals during retirement. To truly max out 401(k) contributions, if you are under age 50, you can contribute a max of $16,500 in 2011. If you are age 50 or older, you can contribute the normal $16,500 plus another $5,500 as a "catch up" contribution, for a total of $22,000. If you are not initially able to max 401(k) contributions, then start with a reasonable amount and gradually work up toward the maximum allowable contribution. The maximums do not include contributions your employer makes.
Take advantage of any free money your company provides, if you are just looking to start your 401(k) and gradually increase your contributions. For example, if your company will put in 50 cents for every dollar you contribute up to 10 percent of your salary, then you will want to contribute a minimum of 10 percent. This way, for each dollar that you contribute, $1.50 will be put into your 401(k) plan. This is sometimes referred to as "meeting the company match," meaning you are taking advantage of all possible contributions your employer provides.
Review your investment options after setting up to max 401(k) contributions. Most 401(k) plans have options ranging from very conservative guaranteed rate cash funds all the way to very aggressive stock funds. You will want to speak with the plan provider financial representatives or your personal investment consultant to decide which options are best to help you meet your investment objectives. If you do not want to ever lose any value in your 401(k), then you will want to invest in the guaranteed return option.
Let your money go to work for you, now that you have made the effort to max 401(k) contributions. You will be pleasantly surprised with how quickly your account value grows as you, and maybe even your company, add money to your 401(k) each paycheck. Your contributions will earn interest, which will also grow the account. The more time you can allow your money to earn interest, the better, as your interest will compound over time. With time and patience, your 401(k) will grow to become a very valuable part of your total financial picture.
Tips & Warnings
- Do not get talked into buying stock mutual funds within your 401(k) if you are not comfortable owning stocks.
- If you leave your current employer, you will be able to roll over your 401(k) to your new employer or to an IRA, Individual Retirement Account.
- Because your contributions are pre-tax, you will pay less income taxes in the years that you make 401(k) contributions. Again, the funds will be taxed when you take withdrawals during retirement.
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