By: Nicole Nelson
A 401k is an employer-sponsored retirement plan. The term 401k comes from the fact that the origination of these types of plans comes from section 401k of the Internal Revenue Code. A 401k plan is a defined contribution plan that lets an employee make pre tax contributions to their plan. 401k plans take money out of employee’s paychecks before they are taxed, reducing taxable income. These funds are then invested into various funds in the 401k plan, decided on by the employee.
401k plans can be very beneficial in retirement planning because of their benefits. One benefit is that the employee is reducing their taxable income, which can be beneficial when paying taxes as opposed to taking money and investing/saving it after being paid. Also, growth in 401k accounts over the year is taxed deferred, again saving money in taxes. Also, many employers give employees the chance to get “free money” from their participation in 401k plans. Employers match contributions (up to a certain percentage depending on the plan) if employees are contributing enough of their own money. Also, it is known that the sooner you start saving, the larger your funds will become in the future. Therefore by putting money into a 401k can easily grow over the years. Another benefit about 401k’s is that you can borrow against your own funds. 401k loans are common and you are technically borrowing your own money. The downside about this is that you loose the chance of earning money on the investments that you will be missing out on because of the loan.