There are lots of things we do in life because we’ve been told they’re a good thing to do. One of those in my life is putting money into a 401K retirement plan. But what does that mean? How does it work?
Lucky for you, the folks at HowStuffWorks.com have written a piece about it.
Four things differentiate a 401(k) plan from other retirement plans.
1. When you participate in a 401(k) plan, you tell your employer how much money you want to go into the account. You can usually put up to 15 percent of your salary into the account each month, but the employer has the right to limit that amount. It might be worth your while to rally for a higher limit if it isn’t as high as you would like it to be. The IRS limits your total annual contribution to $11,000 (for 2002).
2. The money you contribute comes out of your check before taxes are calculated, and more importantly, before you ever have a chance to get your hands on it. That makes the 401(k) one of the most painless ways to save for retirement.
3. If you’re lucky, your employer will match a portion of your contribution. Your employer wants you to participate in the plan because of compliance issues we’ll talk about later. The matched amount they offer (the free money part) is your incentive to participate.
4. The money is given to a third party administrator who invests it in mutual funds, bonds, money market accounts, etc. They don’t determine the mix of investments — you do that. They usually have a list of investment vehicles you can choose from as well as some guidelines for the level of risk you are willing to take. We’ll also talk about that later.
The site is fairly ad-laden, so it’s tricky to navigate, but the content was useful. Take a look-see.
How a 401K Plan Works – [HowStuffWorks.com]
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