If your company offers a 401K retirement plan, you have the option to select the funds you desire to invest. Your choice has to be from a list of funds provided in the 401K plan. Each employee can contribute up to a certain percentage of their pay, which is deducted directly from the salary before taxes into a 401K. Some employers match a certain percentage of your contribution, which is then invested. These funds grow without being taxed. They can be withdrawn only when you reach the age of 59 1/2. You have to pay income tax at the time of withdrawal. The funds in the account can be invested in different stocks, bonds, mutual funds or other assets, and are not taxed on any capital gains, dividends or interest until their final withdrawal.
What is 401K?
A 401K is an employer-sponsored retirement plan and is grouped into two categories.
1. Defined Benefit Plan: The employer promises to pay a defined amount to retirees who meet certain eligibility. It usually links the benefit to the amount of service and final average salary. Employees can either receive it as monthly retirement income or as lump sum on retirement.
2. Defined Contribution Plan: It is a contribution that an employer makes, and not the benefit that employee will receive at retirement. Since it is not a monthly income, an employee receives the amount in a current or deferred lump sum or annuity on leaving the company. Laws prohibit companies from utilizing the 401K money but can invest 401K money in stock fund. However, if your company goes bankrupt then you lose that money.
Benefits of 401K Plans:
There are five attractive key benefits.
oTax advantage
oEmployer match programs
oInvestment customization and flexibility
oPortability
oLoan and hardship withdrawals
How to Balance 401K Funds:
Do not invest heavily in the stock of your employer’s stock heavily. Instead, diversify your investments. Contribute the maximum tax deferred amount to your 401K each year. You can also make additional, non tax-deferred contributions of less than $35,000 or 25% of your annual income. Your age and company’s plan policy is the deciding factor in rebuilding your 401K balances. A younger person will have longer time to rebuild, than a person will over 50 years of age.
The suggested allocation for balancing 401K at three life stages is:
oAggressive- For those with 35 or more years until retirement
50%-large cap stocks
15%-mid cap stocks
15%-bonds
10%-small cap stocks
10%-international stocks
oModerate For those with 20 years until retirement
35%-large cap stocks
35%-bonds
10%-mid cap stocks
10%-small cap stocks
10%-international stocks
oConservative-for those within 10 years of retirement
40%-bonds
30%-large cap stocks
10%-mid cap stocks
10%-international stocks
10%-cash
The maximum benefits from your 401K plan can be derived, if you make wise investment choices and build your portfolio carefully. 401K plans are the best way to plan for your retirement.