It’s smart to take full advantage of your employer’s retirement savings plan.
The best reason for participating in a 401(k) plan is that it can help put you on the road to long-term financial security. Reaching that goal is increasingly your responsibility — though your employer and the federal government help by making a tax-advantaged savings plan available through your job.
Unless your employer enrolls you automatically, you must decide to participate and authorize your employer to withhold a certain percentage of your pay as your contribution. You assign those contributions to investments you select from among those offered in the plan. Together those choices make up your investment portfolio.
The government sets an annual dollar limit on the amount you can contribute, and there’s a catch-up contribution for anyone 50 or older. Your employer may also cap your contribution at a percentage of pay.
With automatic enrollment, your employer chooses the rate at which you contribute and the investment into which your contributions go. You have the right to withdraw from the plan if you wish and to change the rate at which you contribute or how your money is invested.
Getting Started your 401(k)
Building a strong 401(k) portfolio doesn’t just happen. But it’s worth the time and effort it takes. Whether you’re making investment decisions for the first time, or you’re putting your retirement savings portfolio in shape, you’ll want to consider four key factors:
Other retirement assets
It’s important to know what portion of your long-term retirement planning your 401(k) account represents. If it’s just one part of a total portfolio that includes an individual retirement account (IRA), taxable investments, and perhaps a pension or deferred annuity, you may be comfortable concentrating your 401(k) contributions in just a few of the best-performing alternatives your plan offers. But if your 401(k) is the only money you’re putting away for retirement, you may want to balance your portfolio, allocating your account value across the asset classes that are available in the plan.
If you have many years of work ahead of you, you can afford to take greater risks with your 401(k) account. You may want to invest the bulk of your money in stock funds and perhaps a small percentage in company stock, if it’s available. If an investment doesn’t perform as well as you expect — because the manager’s investment style is out of favor or the stock market overall is in a slump — you’ll have time to recoup the loss.
On the other hand, if you’re planning to retire fairly soon, you may want to gradually shift at least some of your assets into less volatile investments to generate income and preserve what you’ve accumulated. Remember, though, that it’s important to keep at least a portion of your assets focused on growth even after you retire.
Your future income needs
Projecting your future income needs can tell you how aggressively or conservatively you should invest. You can assume that you’re likely to need at least 75% to 90% of your final preretirement income to live comfortably after you stop working. You’ll want to figure out how much of that amount will come from other sources, including any pension, individual retirement plan, or annuity payments you may be eligible for, plus what Social Security will provide. Everyone over 25 who is part of the Social Security system gets an annual statement with an estimate of future benefits. If you’re younger than 25, you can request a copy.
Your tolerance for risk
The risk-return tradeoff you’re willing to make is a key element in your investment decisions, both inside and outside your 401(k). It’s a well-known fact that investments posing a greater risk to your principal offer potentially greater returns — along with a greater probability of losses, at least in the short term.
If you’re not comfortable assuming any risk, it’s best to recognize that fact — and its consequences — early on. If you put most of your contributions in insured liquid investments, you run up against inflation risk and the very real possibility that your buying power won’t keep up with your spending needs.
Tax-deferred and Roth IRA
Tax-deferred 401(k) plans let you defer pretax salary to your account and accumulate tax-deferred earnings. The amount you defer reduces your current taxable income. Then, after you retire, you pay income tax on the amounts you withdraw from the plan at the same rate as you pay on your other taxable income.
In the last few years a growing number of employers with tax-deferred 401(k)s have begun to offer the option of contributing to a Roth 401(k) instead. If you choose this alternative, you defer after-tax rather than pretax income and pay no tax on earnings as they accumulate. When you retire, if you’re at least 59½ and your account has been open at least five years, any withdrawals are free of federal income tax and often state income tax as well.
Any employee who is eligible to participate in an employer’s 401(k) can choose to contribute to the Roth option if it’s available. There are no income restrictions as there are with a Roth IRA.
Both tax-deferred and Roth 401(k)s require minimum withdrawals after you turn 70½. But, if you roll over your Roth 401(k) or convert your tax-deferred 401(k) to a Roth IRA, you can eliminate the required distributions. Withdrawals from the Roth IRA are tax free under the same conditions that apply to a Roth 401(k).
Investing In A 401(k) For Beginners. Complete Guide by Inna Rosputnia
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