What is a 401(k) Plan?

The Basics of 401(k) Investing

The 401(k) is one of the most common (and powerful) ways Americans invest for retirement, but many don’t fully understand how it works. With unfamiliar terms and limited guidance, retirement plans make investing feel more complicated than it needs to be. The good news? A 401(k) is actually a straightforward tool once you understand the basics. Let’s break it down so you can invest with confidence!

What is a 401(k) Plan?

A 401(k) is a work-sponsored retirement plan that allows employees to contribute a percentage of their income. The money set aside from your paycheck is then invested in funds that hold stocks and bonds. Employers often offer a dollar-for-dollar match up to a certain percentage of your salary, which is a major perk that can accelerate your savings.

The Employer Match: Free Money

One of the biggest benefits of a 401(k) is the company match. Your employer contributes money to your 401(k) up to a certain percentage of your salary. This is literally free money! If your company offers a match, make sure to contribute at least enough to receive the full benefit.

How Much Should I Contribute?

How much you contribute depends on your financial situation. If you still have high-interest debt or need to prioritize your emergency fund, start by contributing enough to get the full employer match. Once you’ve completed these steps, increase your 401(k) contributions or consider prioritizing your IRA.

Where Do My Contributions Go?

The money you contribute to your 401(k) can be invested in assets like stocks and bonds. Typically, you choose your investments when setting up the account. You generally have two options:

• Target Date Retirement Funds - A single fund that automatically adjusts allocations as you get closer to retirement.

• Choice of Investment Selections - Build your own mix of stock and bond funds.

Target date funds are simple but can limit customization, carry higher fees, and can be too conservative (lower returns). I prefer to select my own investments.

Traditional vs. Roth 401(k)

Many 401(k) plans now offer a Roth option. In a Roth 401(k), you pay taxes now and your withdrawals in retirement become tax-free. A traditional 401(k) allows you to defer taxes until retirement, which reduces your taxable income now. Choose the option that supports your financial goals and long-term tax strategy.

*Tax treatment for 401(k)s is similar to that of an IRA.

Thanks for reading! Subscribe for more personal finance guides and tips!

Start Investing Today

Time is your friend when investing. Here’s a simple breakdown of $250 per month invested by age 65 when starting with $0:

Age 20: $2,156,000

Age 25: $1,327,000

Age 30: $813,000

Age 35: $493,000

Age 40: $295,000

Get started today!

Congrats! You’ve now learned the fundamentals and can get started with your 401(k). A 401(k) plan is a powerful way to save for your future. Many professionals become 401(k) millionaires over time, and using a 401(k) as a key component of your financial plan can set you up for a great future. The earlier you start, the more time your money has to grow. Every contribution you make moves you closer to financial freedom. Cheers to smart investing!

Investing in a 401(k) or other investment accounts involves the risk of loss. This content is for informational purposes only and should not be considered financial advice. I am not a financial advisor. Always do your own research and consider reaching out to a professional if needed.