What is a 401(k)?



You may have just completed your education as a high school grad, college grad, or you may have gone to vocational school. Maybe you are entering the job market and have finally secured a job.


Now imagine as if you were sitting in the office of your employer or the Human Resources department talking about benefits and they mention 401(k) plans.


You might think in your head, “What is a 401k and how does this help with retirement?” while stressing about how you are going to respond to questions about Traditional or Roth 401(k) plans. Don’t worry, this article will help you decide what's best and how a 401(k) works!


History:


401k plans were first created in the 1970’s, by the Kodak company who reached out to Congress and wanted a way to invest a portion of employees’ salaries into the stock market while being tax deductible. Thus, section 401(k) was created in the United states Internal Revenue Service code.


Over the next several decades, some laws would change but the main purpose remained intact.


The Basics:

Today in 2020, 401k plans are common practice among private sector employers in the United states. There are many laws surrounding 401k plans, but most commonly is the Traditional 401(k), which is tax deferred so money deposited is tax deductible, but the money removed after the age of 59 ½ is taxable.


There are many different types of 401(k) such as Roth 401k but for simplicity we will only talk about the basic 401k (traditional).


One major benefit many employers offer is an employer match on your contributions up to a certain amount. Always take advantage of this benefit since it allows you to save more money. Here’s the math:

Let's say you make $70,000 and your employer offers a 3% match up to $2,000 on the money you deposit into your 401(k). If you deposit the $2,000 for the 3% match, you can save an extra $60 paid by your employer to add to your 401k

The $60 is money matched by your employer for just saving $2,000 for retirement. But what if you quit or lose your job, what happens to your 401(k)?


Rules vary depending on the person, company, and situation, but most times are you able to roll the 401(k) over into an IRA. Sometimes employers have rules behind their match on your deposits such as a minimum amount of years you must work for them and other factors. Before signing any papers or agreeing to anything, always read the details.

Realistically, 401(k) plans and its details vary each year and by each employer, so make sure you always ask questions and consult with a professional to make sure your plan is a good plan. Happy saving for retirement!


Written by Ian Cohen


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