National 401(k) Day is celebrated on the first Friday of September every year, commemorating the creation of the 401(k) retirement savings plan. Originating in 1978 as a provision of The Revenue Act 1978, the 401(k) gives employees a tax-free way to defer compensation to make investments without being taxed on gains.
For employees to be eligible, they must be at least 21 years of age and have been working at their job over a certain period. A 401(k) plan may also provide for other employer contributions (such as matching on non-elective contributions).
There are several reasons why an employee would want to contribute to a 401(k), including:
- Tax benefits. Contributions to your 401(k) are taken out of your paycheck before income taxes are removed, lowering your overall taxable income.
- Start early and earn faster. The earlier you start, the more you could potentially make. 401(k)s use compound interest, which means you make interest on the principal amount of an investment plus any accumulated interest. In other words, interest on interest.
- Deductions make it easy. You can set up your contributions to be automatically deducted directly from your paycheck at whatever percentage of compensation you choose. Each plan can vary, so review your specific plan document.
- It goes where you go. If you leave your place of employment where you have your 401(k), you can either choose to keep it with them, have it distributed, or roll it into your new employer’s 401(k) plan.
- Employer match. Many employers will make a matching contribution to your 401(k) plan as compensation, typically between 3% and 6%. Again, check your plan for contribution specifics.
- Higher limits. 401(k) plans allow for the highest contribution limits of any retirement account, including IRA contributions.
As far as how to invest in a 401(k) retirement account, Bankrate.com says there are some important principles to consider when making investments:
- What are your financial goals? Seek the funds that make the most sense for your financial goals. For example, if you want higher returns, you may want to consider investing heavily in stock funds.
- Diversity. A portfolio with diversified funds can help minimize risk and help increase your long-term returns.
- Risk tolerance. Avoid taking too much risk. You want a portfolio that grows with you as your career advances.
- Evaluate your time horizon. If you’re early in your career, you may want to select funds that may be a little riskier but with higher returns. Or if you’re nearing retirement, you may want less risky, more conservative funds.
A 401(k) can be an excellent way to save for retirement. The key is to start early, know your financial goals, and choose funds that align with your growth appetite.
This blog is not intended to and does not constitute legal advice or financial/investment/tax advice. North American Savings Bank does not make any guarantee or other promise as to the results obtained. The consumer should consult a tax adviser for further information regarding the deductibility of interest and charges.