| Topic - An Intro to 401k Plans | Education Center |
For most people, a 401(k) plan is the first retirement plan option to consider. Many companies offer 401(k) plans to their employees. Check with the human resources department in your company to see if they have a 401(k) plan that you can join.
You can contribute up to 15 percent of your salary each year to your 401(k), up to a limit of $10,000 in 1999. For example, if you make $500 a week, you can contribute up to $75 a week to your 401(k).
The money in your 401(k) plan grows on a tax-deferred basis until you retire; you'll pay taxes on your withdrawals at your regular income tax rate at that time.
Many companies match employee 401(k) contributions. If your employer puts in 50 cents for every dollar you put in the plan, you'll only need to contribute $50 while your employer throws in another $25, for a total of $75. You've earned an immediate 50 percent return on your actual out-of-pocket $50 investment. If your employer offers a 401(k) with a match, you're giving up free money if you decline to participate!
The total contributions of you and your employer can't total more than 25 percent of your adjusted salary (your salary minus your 401(k) contribution).
But that's not all that makes 401(k) plans so attractive. Your contribution comes out of your pre-tax salary -- it's deducted from your gross salary before taxes and other deductions.
Here's how you save. Your $75 contribution is taken from your $500 paycheck, leaving $425. Instead of being taxed on a paycheck of $500, your taxes are based on $425. If your payroll taxes amount to 32 percent of your salary, you would have paid $160 to the taxman from your $500 paycheck. But 32 percent of $425 is $136, the taxes you'd pay after your 401(k) contribution. You've saved $24.
Of course, you still had to part with $75 in the first place, but all you're out is $51 ($75 - $24 = $51). That's an instant 33 percent return on your initial investment -- there's no magician who can turn $51 into $75 like that! If your company matches your contributions, it just gets better and better.
Don't look this gift horse in the mouth. The first step in your retirement plan is to contribute the maximum you can to your 401(k) plan.
If you work for a non-profit organization, your employer might offer a 403(b) plan. These are quite similar to 401(k) plans, except that you can usually only invest in mutual funds and annuities. The same rule for 401(k) plans holds true: put as much as you can afford into your 403(b) plan.
In 1997, the tax laws were relaxed to allow non-profit organizations to offer 401(k) plans.