For most people, a 401(k) is a retirement plan. It’s a savings investment plan that is established by your employer. Even after you’re no longer with that employer, you hold onto your 401(k), and it can transfer to newly qualified employers.
Before signing up, you may ask, “What does a 401(k) plan generally provide its participants?”
What Does a 401(k) Plan Generally Provide its Participants and Why a 401(k) is a Good Idea
While it’s best to get established with a 401(k) when you’re in your twenties, it’s never too late to get started on investing in your future and your retirement. The sooner you get started, the more money you’ll have toward retirement. Signing up is easy when you work for a company that offers a 401(k).
This investment plan runs on you adding money, your employer adding money and the annual return rate on your plan. There are calculators, like this one, online that can help you determine how this investment will grow as you work your way toward retirement.
Many businesses match the amount you put into your 401(k) from each paycheck.
If you no longer work there, you can still put money in from a new employer (in most cases), and your investment will continue to grow by your annual return.
Your investment to the plan is pre-tax, so your paycheck only loses taxes for the amount you’re getting, and you don’t pay taxes on the money in your 401(k) until you make a withdrawal.
The History of 401(k) Plans
You may wonder why this employer-backed investment plan has such a strange name. If it seems like a weird code name, it’s because it’s from the tax code section that governs the 401(k).
These plans were started in the 80s and were a replacement for pensions. At that time in history, having pensions for employees was no longer cost-effective for many businesses, but they wanted to continue offering a retirement plan to their dedicated employees.
401(k) and Investing Your Money
The 401(k)is not just a savings plan; it’s an investment plan.
You are investing the money you’re saving to make a bigger return. The investment portion of the plan is one of the things that is sometimes misunderstood by newbies to investing. Even though your money is going into specific investments, you are in control of where it goes.
You may be able to spread your funds across different platforms, including stocks, money market investments, and bonds. Most people opt for a combination of bonds and stocks. Your money is what you’ll work with since there are stipulations on when you can work with the money invested by your employer.
Even if your investment swells, you can’t just pull your money out when you want to. There are rules set forth to determine when you can withdraw, and there are penalties for withdrawing your funds before you reach the age of retirement.
Your Employer and Your 401(k)
Aside from putting a contribution into your investment, your employer also oversees your account (at least while you’re working for them). They’ll have an administrator that keeps track of your account, and you’ll get emails or snail mail updates that let you know how your investments are performing.
Keeping watch on your investments is important. There are times when you’ll want to move some of your money around, depending on how your current options are performing.
What Happens When You Quit?
When you leave an employer, there are a few options for what you might do with your 401(k) plan. Some of these options will depend on your employer. It’s likely you won’t get regular notifications anymore, which means you won’t get important information on changes to your investment either.
You may be able to move your plan to your new employer. Again, this depends on your plan and rules set forth by your original employers that supplied the 401(k). You could opt to cash out your account. In this case, you’ll pay taxes and penalties for cashing out early, and you’ll no longer be earning money toward your retirement.
The best option to go with is to do a direct rollover into an IRA, which will allow you to keep growing your nest egg, and your money will still be tax-deferred.
Are You Invested?
If your company offers a 401(k) – you should sign up now. Don’t wait. Don’t talk yourself out of it.
If you don’t have some sort of retirement plan, you’ll never be able to step away from work and enjoy your senior years. You also want to make sure to have a beneficiary on your account, so your money goes somewhere in case of your untimely death.
So, what does a 401(k) plan generally provide its participants? Now you know the answer.