What Are the Advantages of Investing In A 401k?

Most individuals realize the importance of having a retirement savings plan large enough for to carry them through their retirement years (preferably in style). But those who are just starting out in the working world or who haven’t been in the work force for very long, may be underestimating the importance of saving for some far off date.  Retirement is 40 years off!  I’ve got plenty of time to save!  Right?  Wrong.

There are many options for saving for retirement (you can have more than one).  No one account will fit with everyone’s goals and financial situation (thanks to Congress’ convoluted retirement plan rules). But for most people, the good ol’ fashioned 401k plan fits the bill. People of any age who hold a job may have access a 401k account sponsored by their employer.  Taking advantage of your 401k’s tax-deferred investment options will multiply your wealth over time.

How Does a 401k Work?

A 401k is a retirement plan sponsored by an employer for the benefit of its employees.  Workers are allowed to divert a set portion of every paycheck directly into their 401k account before it ever hits their checking account.  Since workers never see the money show up in their checking account, they aren’t tempted to spend it.  This turns out to be a huge psychological advantage of 401k’s versus simply saving on your own somewhere else.

Tax Advantages of 401k’s

401k contributions are made with pre-tax money. You don’t pay taxes on your contributions until you withdraw the money from the account at a later time. You also reap the benefit of having your Adjusted Gross Income (AGI) being reduced by the contribution amount.  This means an increase in retirement savings and a decrease in taxes.  Can’t beat that.

Penalties To Avoid

There is a 10% early withdrawal penalty for withdrawals made from your portfolio before age 59 1/2 in addition to any regular income taxes owed.   As you might guess, it’s a very bad idea to withdraw money from your 401k before you qualify.  In uttermost need, there are a few specific hardship withdrawal exceptions you can use to get at your money penalty-free (you may also qualify for a 401k loan, not recommended).  If you end up leaving or losing your job for whatever reason, you have several 401k rollover strategies to consider, the most common of which is rolling over your 401k to an IRA.