Until my not so graceful plunge into adulthood, I only had the vaguest idea of what a 401(k) was. I knew my parents had them, I knew they were for retirement and had something to do with investing, but that’s where my knowledge (and quite honestly, my interest) stopped. Now that I’ve been in the workforce for a while and found a refreshed interest in personal finance I thought I should help you all out by putting some of the 401(k) basics all in one place.
401(k) accounts are essentially investment accounts provided by your employer for retirement. If you have a 401(k) available to you from you employer, you should be taking full advantage of it if you are not already.
How it works:
- Your employer takes a % (you determine how much) out of your paycheck before taxes are taken out and that money goes directly into your 401(k) account.
- Often they match a certain percentage. For example, they’ll match up to 3%, so if you put in 3% they’ll match it, so now you have the equivalent of 6% of your paycheck in your account, even though you only contributed 3%. If an employer matches or how much they match (up to 3%) is up to them.
- You use the money in the account to invest in different funds, and wait until retirement to use it.
- When you take it out at 59.5 or older, you pay the taxes on it.
The big idea behind a 401(k) is that you don’t pay taxes on it now, you pay taxes on it later when you take it out with the hope that you will be in a lower tax bracket when you retire.
There are some rules for 401(k)s:
- You can’t take anything out before you’re 59.5 without large penalties. You can borrow against it, but this is an “advanced” topic
- You can only contribute $18,000 a year (as of 2017) unless you’re over 50, in which case you can contribute up to $24,000
- You can only invest in the funds they allow-some plans are more restrictive than others.
This is just a brief overview of 401(k)s to get you started. There’s so much more, such as the difference between different retirement accounts, basic asset allocations and other frequently asked questions, check back for more!