Who Else Wants to Retire Some Day Without Having to Worry About Money

Important Concepts to Know About Your 401(k) Retirement SavingsAre you ready for retirement? This may seem like a funny question, especially if you’re a college student or a recent graduate. Retirement seems like a very long time away, so it’s not exactly at the top of your to-do list, right?

To be honest, it’s never too early to start saving for retirement. Thanks to the magic of compound interest, the longer you save the more earnings you gain. This is precisely why now is the best time to start saving up for your golden years. You shouldn’t wait till you’re “more stable” or “earning more”. Saving early can make a real difference.

Do not make the same mistake that earlier generations made. The Employee Benefit Research Institute revealed that 57% of employees in the United States have less than $25,000 in savings. Unsurprisingly, 28% of Americans fear that they don’t have enough money tucked away for retirement.

The time to save is now, but you can’t just go in blindly. Here are ten important concepts of the 401(k) that you need to understand:

Contributions

The contribution is the amount of money you put into your 401(k) fund. There is a limit to the amount you can contribute per year ($17,000 as of 2012).

Matching Contributions

Most companies offer incentives to encourage their employees to save up for retirement. The match rate differs depending on the company, but most employers will offer to match the amount you put in, so that they double your 401(k) contribution. Make sure to ask about the requirements, though. Most companies will require employees to stay with the company for at least a year (may vary) before the match rate takes effect.

Eligibility Period

Not all employers will immediately enroll employees in a 401(k) plan. It’s best to ask, because different companies have different policies. Some require the employee to stay with the company for at least six months; others require a whole year before the employee becomes eligible for the 401(k) plan.

Vesting

Your employer’s matching contribution isn’t really “yours”, yet. The “vesting period” refers to the gradual process by which the employer’s contributions become truly part of your 401(k). This means that if you leave the company before the vesting period is up, you won’t get all of the contributions your employer put in (you can still have the amount you contributed, of course). The typical vesting period is five years.

Investment Fees

A 401(k) plan incurs quite a few fees. You may have to pay for investment management, account keeping, and more. Since the fees are taken out of the account itself, most employees don’t realize how much they’re paying to keep the plan going.

Loans

The Internal Revenue Service leaves the matter of loans to the employers. Most companies do not allow loans on the 401(k). Those who do often set limits, allowing 50% of the total vesting balance for loan purposes.

Taxes

If you withdraw money from your 401(k) before you reach 59½ years old, your withdrawals from the account will incur a penalty tax of 10%. The withdrawal is also subject to income tax. This is because the IRS wants to discourage employees from drawing from their retirement fund before actual retirement. However, certain allowances and exemptions may be applicable for disabilities and other specific financial needs.

Forced Withdrawal

At age 70½ , you will be required to withdraw from your 401(k). Otherwise, the amount earmarked for distribution will be subject to an excise tax. However, if you are 70½ but still employed, you have the option to not withdraw from your retirement fund until the year you finally retire.

Roth 401(k)

This is an alternative to the traditional 401(k) plan. Basically, the primary difference is that the traditional 401(k) takes pre-tax contributions from employees, while the Roth option accepts post-tax contributions. It is possible to have both the traditional and the Roth versions to diversify your retirement fund portfolio.

Voluntary

What you should realize is that your employer’s 401(k) offer is voluntary. You have the right to opt out if you think you can get a better retirement fund somewhere else. In fact, it’s best to have a separate retirement fund that isn’t tied to your employer, so that the 401(k) shouldn’t be a major deciding factor in terms of your career choices. Of course, you can always contribute to your employer’s 401(k) and still have a personal retirement fund or portfolio somewhere else at the same time, to increase diversification and ensure retirement flexibility.

 

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