401k Retirement Stock Tax Advantage
If you are passing up the opportunity to invest in your company's 401k plan, you might want to reconsider that decision. Investing in a 401k allows you to save money for retirement, but that investment also carries a number of tax benefits. From tax deferred growth to lower current taxes, you have many reasons to invest in your 401k plan.
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Payroll Deductions
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The money deducted from your paycheck to fund your 401k is not subject to current taxation. That lowers your taxable income, which in turn lowers your overall tax liability. The generous limits for 401k plans allow workers to shelter far more money than they could elsewhere, providing an excellent up front tax benefit. For instance, the 2010 IRA contribution limit for a worker 49 years of age or younger is a mere $5,000, while the 401k contribution limit for the same worker is $16,500. Workers 50 years of age or older can contribute just $6,000 to an IRA, but they can salt away $22,000 in their 401k plans.
Dollar Cost Averaging
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Investing in a 401k plan is the perfect way to take advantage of the power of dollar cost averaging. When you dollar cost average, you put the same amount of money into your favorite investments, regardless of how well or poorly those investments are faring at the moment. The simple act of investing with the same amount of money each time means buying more shares when the stock or bond market takes a hit, and fewer when it is riding high. Since the money in your 401k grows tax deferred, you can profit handsomely, with no tax consequences, each time the market recovers.
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Tax Deferred Growth
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One of the biggest advantages of a 401k plan is that the money grows tax deferred all the way out to retirement. If you are a young worker, that means you could get decades of tax deferred growth for your portfolio. The money you accumulate in your 401k is only subject to taxes when you actually withdraw those funds in retirement. At that time, those funds are subject to ordinary income tax at the prevailing rates in place at the time.
Minimum Distributions
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After you retire or leave your job, you can roll the money in your 401k plan over into an IRA. Once the money is in place in the IRA, you can begin withdrawing that money when you reach the age of 59 1/2. You can choose to withdraw only as much as you need for current income, and the rest of the money in the account continues to grow on a tax deferred basis. When you reach the age of 70 1/2, you must take a minimum distribution from your retirement account. The amount you are required to withdraw is determined by the IRS based on a formula that takes the balance of the account and your life expectancy into account.
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