Unless you have a finance degree, the topics of a 401l(k) and investing are generally tedious topics for most folks. Learning about some of the key terms can make the topic a little easier to digest. While I am not a financial advisor and do not aim to give financial advice for investing in a 401(k), the only qualifying tip that I can give is that the earlier you start investing, the more prepared for retirement you’ll be.
401(k): A Crash Course
What is a 401(k)? The name 401(k) is derived from the Internal Revenue Code, section 401, subsection k, which talks about qualified pension plans. A 401 (k) is a pre-tax account that allows you to set aside money on a tax-free basis. Though note you will have to pay taxes on the money once you take the money out. In 2017, the IRS set the contribution limits to $18,000 per year and those age 50 or older may contribute an additional $6,00 per year.
Why contribute to a 401(k)? Other than the tax benefits, many employers will match an employee’s contributions to a 401(k). That means free money for you! For example, an employer may match 100% of the first 5% that an employee contributes. This means if you contribute 10%, the will match 5% and if you contribute 3%, they will only match 3%. You’ll need to check with your HR department to find the full details of your company’s match rate.
What is Vesting? It sounds like a nice fall vest, but it’s much more useful than that. As an incentive to retain employees, many employers have a vesting schedule for their 401(k) retirement plans. Being fully vested indicates that you have full ownership of the funds in your account. While you will always have full ownership of the funds you contribute, the funds your employer contributes may be taken away if you aren’t fully vested. For example, if there is a five-year vesting schedule, you may keep 20% of the money the employer has contributed to your account until you reach five years of service, and then you will have 100% ownership of the funds. To learn the specifics of your company’s vesting schedule, contact your HR department.
When can I have my money? Because a 401(k) is for retirement income, there are penalties should you decide to withdraw the money before you’ve reached retirement age. Retirement age is defined as 59 ½ and if you withdraw money before then you’ll be subject to paying income taxes as well as a 10% early distribution tax penalty. It’s best to not touch money set aside in a 401(k) unless necessary.
To get started, contact your HR department and they can tell you the full details of the plan they offer. In addition, the group that manages the 401(k) for your company will have a representative that will be able to guide you through the investing process. There is no better time to start than today.