What Is a 401(k)?

Updated : Sep 10, 2019 in Articles

What Is a 401(k)?


What exactly is a 401(k), and what do you
need to think about when you sign up for one? Let’s break it down. A 401(k) is an employer sponsored retirement
savings plan that includes special tax advantages. Some employers match a portion of their employees’
contributions. For example, an employer might offer a 5%
dollar-for-dollar match. This means that for every dollar you contribute
to your 401(k), your employer will also contribute one dollar, but the match is limited to 5%
of your salary. Think of this as “free money,” and we
recommend you contribute at least the amount needed to receive your full employer match. In this example, keep in mind that if you
decide to contribute more than that 5%, your employer won’t match the additional contribution. Every 401(k) plan is different, so the options
available will depend on your specific plan. Contributions to a traditional 401(k) are
not taxed going in, so they can reduce your taxable income. Later on, withdrawals are taxed, including
any earnings your contributions had. Your employer may offer you the ability to
make Roth 401(k) contributions. With a Roth 401(k), you pay taxes at the time
you contribute, but you won’t be required to pay taxes again on your contributions or
investment earnings when you make qualified withdrawals in retirement. Some people borrow from their 401(k) for major
purchases like a home or education. That may be allowed, but it comes with some
significant downsides and risks including giving up potential earnings and potentially
paying taxes and penalties if you default on payments. So, it’s best to think of your 401(k) as
a long-term investment account that’s meant to be used for retirement. You should use other accounts for emergencies,
or as a way to pay for other savings goals. To learn more about how to take control of
your financial future, check out the other videos in our Finance 101 series.

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