07.12.07 | What is a 401k and why should I care?
You just got a part-time job for the summer (or are starting your first full-time position). Someone from HR provides you with a benefits packet. You glance through it and try to make sense of it all - Health insurance? Got it. Life insurance? OK. Vacation days? Definitely. 401k plan? Ummm..huh?
The 401k is something you should certainly understand. It’s an investment plan that allows you to take pre-taxed money and deposit it into a separate account for your retirement (or at least until you are 59 1/2.). Usually, your company will provide you with a series of investment options - these will most likely include a variety of mutual funds or company stock. Once you reach the withdrawing age, you should then have a great deal more money because you’ll have the initial principal you invested plus all the interest you earned from your investments in mutual funds, stock, etc. Since your money isn’t taxed when you make the initial deposits, you are taxed at whatever your income tax rate is when you withdraw - ideally, a much lower amount than when you were working.
Sounds complicated - what’s so great about all this?
There are a number of reasons why you should participate:
1) Many, many companies offer a company match. This means that if you contribute 3% of your salary to your 401k, the company will also contribute 3% (or whatever their matching policy is). So, if you add $50 a month, your company may also add $50 to your account. Yes, this is free money!! Yes, you should take advantage whenever you can!!
Why do they do this? Because saving for your future is very important and most companies understand this. Therefore, assisting their employees boosts morale = happier employees = better productivity.
2) The fact that the money is deposited on a pre-tax basis means that you’ll actually get more money than if you just threw your post-tax money into stocks or a savings account. Say you’re in a 30% tax bracket, and your gross pay is $1,200. If you sock 3% of your paycheck into a 401k account, that $36 you’ve saved isn’t hit at the 30% tax rate. Very nice.
3) If needed, you can use this money in an emergency. You’ll be penalized a bit but if you need the money, you need the money.
Clearly, the company match is the main reason why workers participate in this program. And, if your company is one of them, there’s no reason why you shouldn’t either. It’s free money!