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Faqs About Your 401(K)

Faqs About Your 401(K)

September 28, 2020

401(k) is a common term used throughout the business world. However, if you are just entering the workforce, or looking into retirement opportunities for the first time, you may not know how a 401(k) works. The guide below will answer some common questions you may have about your 401(k).

What Is a 401(k)?

A 401(k) is an account designed to help you save for retirement. Contributions to this account are never mandatory, but these accounts are a great way to save money.

The economy is always changing. Regular bank accounts have small interest rates that do not change over time. However, 401(k) accounts offer investment packages. With steady investments, your money will keep up with inflation and the changing economy.

401(k) accounts usually provide different investment options so you can choose where you want your money to go. Instead of buying stock directly, you can save on fees by contributing to your 401(k).

How Does a 401(k) Save Me Money?

When you invest in your 401(k), you get more than a bundle of investments. Many companies will match your contributions up to a certain limit. In essence, companies will pay you to invest.

Let's say a certain company will match your contributions to your 401(k) up to 5% of your salary. If you earn $60,000 and invest 5% ($3000), your employer will match your contribution and add another $3000 to your account — you get double the money you invested. However, if you invest $4000, your employer will only match the first $3000.

How Do Taxes Affect My 401(k)?

There are two types of 401(k) plans. Each plan deals with taxes differently, but also has an associated risk.

A traditional 401(k) saves you money on taxes in the beginning. When investing in your 401(k), you do not pay taxes on your contributions. This may end up putting you in a lower tax bracket, which could save you a lot of money in the beginning.

Instead, you pay taxes when you withdraw the money from your account. You pay taxes on both the contributions you have made as well as earnings from the investments.

In a Roth 401(k), you pay taxes on your contributions at first, but not on your later withdrawals.

Since nobody can accurately predict what future taxes will look like, both types of 401(k) have the risk of you losing money in the long run. Most financial consultants will advise you to invest in both types of accounts.

How Do I Withdraw from My 401(k)?

The rules for withdrawing money from your 401(k) account also differ based on what type of account you have.

Money invested in a traditional 401(k) account is more difficult to withdraw. Once you invest, it is difficult and expensive to withdraw your money before the age of 59 and-a-half, or if you leave your company when you’re over the age of 55. If you withdraw your money before that time, you immediately get a 10% penalty and must pay taxes on your withdrawal.

A Roth 401(k) is a little more flexible. As long as you keep the same account for over five years, you can withdraw your money for free. However, a 401(k) is designed to be a long-term investment for retirement. You do not want to use it as a savings account.

A 401(k) allows you to save for retirement by making secure investments. Instead of having to manage a portfolio yourself, your employer will keep track of your investments so you don't have to worry. To get the most money out of your account, you want to take advantage of your employer's matched contributions policy and invest as much money as your employer will match.

Don't pass up the opportunity to invest in your 401(k). Your future self will thank you for it.

At Presidio Wealth Management, we assist our clients in every aspect of their financial lives. We offer personal service to help you find financial stability and financial independence.