Let’s assume that you got a notice from your employer that you’ve qualified for the company’s 401k. Or, you need to know how 401k works to help you make the right decision. What you need at that point information on how 401k works and how you can get started. This post outlines the process of how to start a 401k.
What is a 401k?
A 401k is an employer-sponsored retirement account which enables an employee to save and invest for retirement. It is not limited to employees alone. As a business owner, you can open a solo 401k account. The aim is to save a portion of your earnings every week, bi-weekly or monthly. The money saved up is invested in different investment options.
How is the 401k Account Taxed?
Before you start a 401k, you need to understand how the 401k account is taxed. The amount you save in your 401k is not taxed until you make withdrawals. The same thing applies to the profits from the investment. At the time of withdrawal, the tax rate then applies. Check this post to learn more about how 401k works.
Investment Options Available For Your 401K:
Once you become eligible for a 401k in your workplace, you have the option to pick investments for your savings. Your employer most times provides a list of investment options available for you to make a choice. Compared to an IRA, the investment options available in a 401k is limited. Remember to choose your investment options. If not, the default investment applies, and this may not be a good choice for you. These are the investment options available for you in a 401ka.
Bonds investment is one of the investment options available for a 401k investment. You can invest in either corporate or government bonds depending on the options available. The good thing about bonds is that it is a safe investment option. There is rarely a default in payment on the bonds investment. It is also recommended if you have a low-risk tolerance. The disadvantage is that the return is usually on the low side.
This means buying into the shares of a company. Stock investment is a good investment option, but you need to know how to analyze the financial market. The stocks available for a 401k are usually limited. The returns on stock investment are generally on the high side. The downside is that it is risky because the stock can lose its value.
c. Mixed Investment:
The mixed investment is a combination of bonds and stocks. To an extent, this is the best option for a 401k. The stock is a high-risk investment option has a better return while the bonds are there to cushion the risk associated with the stock investment.
d. Money Markets:
The money market is similar to a certificate of deposit. It is usually a safe investment option. For the money market, you have to maintain a required balance in the account to earn interest. The advantage is that it has a low-risk. The downside is that the returns are meager that inflation catches up fast with it. It is not the best option for a retirement investment plan. Also, note that most 401k investment option has a money market as its default investment option. That is why you must pick an investment option else the default, that is money market, will become the applicable option.
Factors to Consider when Determining the Amount to Invest in a 401k:
a. Limit: There is a limit to the amount you can contribute to a 401k. The limit is $52,000 if you are below 50 years and $57,000 for people above 50 years. This limit includes the employer’s contribution too.
b. Employer’s Match: An employer’s match is the amount your employer opts to contribute to your 401k. Your employer may choose to match your contribution with a certain amount or percentage for the period. Always take full advantage of your employer’s match. For instance, your employer may opt to match every dollar you contribute by 50% for your first contribution. If you choose to contribute $10,000, this means your employer will add $5,000 to your funds.
How Rollover 401k Works:
When you change jobs, you have the option to roll over your 401k or start a new 401k with your new employer. To roll over is to transfer your existing 401k to a new employer plan. If your former boss has a better plan or better investment options, you may consider leaving the 401k. On the other hand, if you opt to rollover your existing 401k you need to know how to go about it. First, you have to decide if you are rolling over into a new 401k account or to an IRA. If you are rolling over your existing 401k to a new 401k, a check will be written directly to your new 401k. That is the best option and saves you from paying some cost associated with getting the check directly.
With this information, you can make an informed decision on the options available when starting your 401k.