So Many Shoes, So Little Money – Blog

401K

June 2nd, 2009

Retire, who me?

A 401K, is a retirement plan your employer can offer you if they so desire. Yes, I know retirement is a long, long way off but as a fashion fashionista you know how good it is to start saving early. You can only get a 401K through your employer. A 401K automatically takes money out of your paycheck—you decide how much, up to the federal limit—and deposits it into a retirement savings account set up for you. You then decide, based on the options the employer provides how your retirement account will invest your money. Usually your employer will offer a range of choices, ranging in risk from preppie conservative to cutting-edge fashionista.

The money you allow your company to deduct from your paycheck and put in your 401K is deducted pre-tax, meaning before you pay taxes on it. In other words, you do not have to pay any taxes on the money you put in. You get to invest this part of your paycheck, earn money on the government’s share of its taxes, and keep the money you earned on that share when you eventually withdraw the money from your account and pay the taxes on the amount you withdraw. So you have the use of the government’s money to earn interest until you are sixty-five or older and can withdraw the money.

If your employer offers a 401K plan you should take full advantage of it. It will force you to save because it takes money out of your paycheck before you ever see it. Plus, it will lower your tax rate, since it is money you won’t be taxed on, and, even better, some employers offer you an incentive to invest in a 401K by contributing to your account as well, which should make participating irresistible.

The amount your employer contributes is called a matching contribution and usually consists of a percentage of your paycheck up to a defined maximum. For example, an employer might offer to match you fifty cents for every dollar you contribute up to some specific percentage of your salary, usually three or four percent. So over the course of a year, if you invested one thousand dollars, your employer would deposit five hundred dollars into your account. This is like getting an instant raise with no extra duties required.

If you leave the company, you can take the 401K account with you and roll it over into an Individual Retirement Account (IRA), a kind of stand-alone 401K, or leave it with your former employer to administer even after you leave. Sometimes they charge you a fee for doing this so I suggest rolling it over into an IRA. (Also, if you plan to have more than one employer before you are sixty-five, it is nice to keep your accounts together in one place that you control.) IRAs are more flexible than a 401K; your money can be invested in whatever you want, not just what your employer has chosen—from stocks and mutual funds to bonds and real estate. There are lots of different kinds of IRAs so you need to check them all out. The downside of IRAs is there is a limit on the amount you can invest in them each year, although 401K rollovers are exempt from this limitation. The limit changes so you need to look up the limit for a particular year. You can Google “IRA” to learn more.

Filed under: Net Worth

Tags: saving