If you live in a country where a 401(K) is available then congratulations, however, many countries have similar plans, just called something else. Not everyone is offered a 401(K) but if you do have a job which offers you one then extra congratulations to you.
Your 401(K) is basically a retirement account, which offers up certain advantages. We are going to explore those advantages today so you can take advantage of them and maximize your saving potential.
1. YOUR 401K
The 401K is a retirement plan offered up by your employer. Basically an employer sponsored savings plan. If your employer offers one as part of your benefits package then you can take advantage of it. You tell your employer how much you want to contribute and they will automatically deduct it from your pay package. For 2018 the amount your are able to contribute per year is $18500 but if you are over 50 you can contribute more if you wish.
2. EMPLOYER MATCHING
One of the main advantages offered to you in the 401K plan is that most employers will offer up a matched amount, dollar for dollar, up to a certain percentage. The percentage which your employer is willing to match should be explained to you when you sort out your payment package. YOU SHOULD MAXIMIZE THE AMOUNT. If your employer is willing to match 4% of your salary then you should aim to pay in 4% to your 401K. Why? Because it is free money. If they will match 4% but you only pay 2% then you are leaving 2% on the table. In basic terms: if your employer will match up to $3000 but you only put in $2000 then you have missed out on a free $1000.
3. TAX BENEFITS OF YOUR 401K
So what are they? When you contribute money into a 401K you don't have to pay taxes on that money until you withdraw it. Contributing more into your 401K means you reduce your taxable income on your pay check. Paying tax on your 401K when you come to withdraw it isn't a great set up, however, it means you can compound that non-taxable money over the years so it kind of makes sense to max out your 401K contributions. See our post about a ROTH IRA for further tax advantages.
4. INVESTING
Each 401K has different options which are available to you. It doesn't have to be as simple as sticking money into a 401K account. Take it upon yourself to research the options which are available to you. Generally, your age and risk profile will determine the ratio of your allowances, i.e how much you can contribute to riskier options, such as stocks and how much you can contribute to 'safer' assets such as bonds. Generally, the younger you are, the more time you have to play with riskier investments to try and maximize your returns. As you grow older you may then start shifting your money into safer but less lucrative options.
5. LIMITATIONS
It isn't all sunshine and rainbows with your 401K, there are restrictions. You are limited to the amount you can contribute every year because Mr tax man wont allow you to put too much of your income away as they need tax dollars sooner rather than later. I stated earlier you can contribute $18500 as of now but this is likely to change over the years so keep an eye out for any increases and get smashing that extra little bit in whenever you can.
Want to withdraw money? You should probably wait till you are 60. Well 59 and a half to be exact. This is because if you start withdrawing before you are that age then you will incur penalties for your early withdrawal. This is a bit of a pain and why you should also open something like a Roth IRA and normal savings account, which enables you to balance both money for sooner and later in life.
My opinion:
A 401K is a great way to save for retirement but you shouldn't completely rely on it. The main benefits are that your employer will match a certain percentage (free extra money) and that you can have less taxable income on your payslips, although you will have to pay tax eventually. I wouldn't put all my faith in a 401K, however, i would use it as part of my retirement plan. Whatever percentage my employer is offering to match, i would pay in that exact percentage and then use any other money to invest in things outside my 401K; Roth IRA, stocks, bonds, crypto, property etc.
What is your approach to a 401K? Let me know in the comments.