Finance Column: Why You Need a 401k

We have all been there before. You start your very first job out of college, and they hand you a stack of paperwork to fill out and tell you that you need to enroll in benefits and your 401k in the next 2 days or else you will have to wait entire year to enroll again. You start to feel overwhelmed, stressed out by all the data and really confused by this account they call a 401k.

You’ve probably asked yourself, What the heck is a 401k and why do I need it?
A 401k is a type of retirement savings account offered by an employer in the United States. It allows you to save for your retirement, something that is extremely important and something many people in their twenties (and thirties!) don’t even think about. Here are some key things to know about a 401k plan.

  • 401k plans are retirement plans offered by employers. If you are self-employed, you may want to consider starting an Individual Retirement Account, better known as an IRA.
  • The amount you decide to contribute to your 401k plan is up to you. However, there is a maximum contribution amount, and the maximum in 2012 is $17,000.
  • A 401k is just the name of the account. It is not the name of your investment within the account. You will have to decide how to invest your money once it is inside the 401k.
  • You can leave it in cash or invest it into something else that is offered within the plan. Usually people invest their money into mutual funds that are offered within the plan.
  • There are many tax advantages of saving into a 401k. For example, the contributions you make into your 401k are tax-deductible. That means you can deduct the 401k contribution from your gross income for the year, therefore reducing your overall tax liability for the year.
  • The money that is inside your 401k account grows tax-deferred, meaning you do not pay any taxes on any growth you may have on the account during the year.
  • Your employer may match your contributions. If they do, I suggest you at least save as much as the match. This is FREE money.
  • You have to be 59 ½ years old to withdraw the money without any penalties. At that time, you pay ordinary income taxes on any amounts you take out.
  • You can rollover your 401k if you leave your job. You can elect to rollover your 401k into an IRA or a new employer 401k plan.

I hope this helps you better understand the 401k plan. Remember, it can quite complex so if you are still in need of clarification or advice on what to do with your 401k, I suggest you work with a CERTIFIED FINANCIAL PLANNER who can help you better understand how a 401k may be right for you.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

This post was contributed by Brittney Castro, a Los Angeles CERTIFIED FINANCIAL PLANNER™ practitioner and creator of Brittney Castro, CFP® helps create a financial road map for a woman’s different goals in life. She also educates clients on different options, enabling them to make smart decisions. She has a passion for educating individuals on financial topics and speaks for various groups and organizations. Brittney Castro is available for speaking engagements, radio and telephone interviews, and other media appearances. Connect with Brittney at Brittney Castro is not affiliated with Brittney A. Castro is a registered representative with and securities offered through LPL Financial, Member FINRA/SIPC. California Insurance License #0F33895