Basics of a 401(k) Retirement Plan
Understanding this important employment benefit could put you on a path to future wealth.
As of 2018, more than 58 million Americans were active participants in an employer-provided 401k. But many more were not taking advantage of this important investment opportunity, most simply because they weren’t clear on how they worked or what the advantages or disadvantages were.
If you’re considering opting into your company’s 401k program, there are just a few things to understand so you can make the most of your investments.
A 401k is an employer-sponsored retirement plan. It’s offered as a benefit to attract and incentivize employees and to help them save for their future. Sometimes, an employer may choose to match an employee’s contributions to their 401(k), providing even more benefit and wealth-growing power.
- An employer typically offers employees a variety of plans to invest in, and these plans are managed by an outside financial services advisory group, not the employer.
- The most common options are mutual funds, which pool investor money to buy a balance of stocks and bonds to provide diversification and stability.
- Employees can choose plans that are geared more toward aggressive growth or ones that are more conservative, depending on their age and level of risk tolerance.
How a 401k Works
An employer will help you enroll in their 401k program, and the outside advisory group managing the funds will help guide enrollees in choosing which plans are the best fit based on goals and risk tolerance.
You decide a monthly contribution to be deducted directly from your paycheck into your 401k account.
Some employers offer a “match” program as a further benefit. What this means is they will match your annual contributions to your 401k up to a certain percentage of your salary, typically around 5%. So if you make $100,000 annually and contribute 5% or more of it to your 401k, your employer will also contribute up to 5%, or $5,000. If you don’t contribute, you don’t get the matching funds.
Advantages of a 401k
Investing in a 401k has a few very clear advantages.
- You’ll save on taxes. Money that goes into your 401k comes out pre-tax, meaning it comes straight from your paycheck and you pay no annual income taxes on it. Instead, you’ll pay taxes on the money in the future, when you withdraw it after retirement.
- Employers may match contributions. Another way to look at this? Free money! You could gain thousands of additional dollars to invest by taking advantage of a 401k with employer matches.
- Your money will grow exponentially through compound interest. As your investments grow and earn interest, they then earn interest on that NEW amount, causing your money to grow even if you don’t contribute another dollar over the years.
A last thought—many people don’t take advantage of their 401k options because they’re living paycheck to paycheck or don’t think they have enough to make it worthwhile. But there is no minimum amount you can contribute, so the most important thing is just to get started. Once you see how quickly your money can grow, you’ll be inspired to keep contributing.
At Aspen Wealth Strategies, we love helping clients with their 401ks and can help you decide which plans are right for you or how much to contribute.
Contact one of our advisors to help you take the guesswork out of your 401k today.