So, what is a 401k plan anyway? For some of you, this may seem like a pretty silly question, but a surprisingly low number (44%) of employees in their 20's, who have employers that offer and match 401k contributions, take advantage of this savings plan. When you are looking for a job, you will find companies who offer benefits like health insurance and 401k plans and others who don't. If your employer offers this type of savings plan, it is a good idea to have a firm understanding of what it is, so that you can decide if it is a good choice for you (hint – It almost always is).
According to Wikipedia, a 401k plan is “a savings plan that allow employers to help their employees save for retirement while reducing taxable income … workers can choose to deposit part of their earning into a 401k account and not pay income tax on it until the money is later withdrawn … Employers may choose to, and often do, match contributions that workers make.”
So, what does that mean in practice? Well, to help us out, the financial advisers at Mint have come up with a great infographic to help explain things:
Mint.com Personal Finances
Well, that helped – a little. It seems that there are two different types of 401k accounts. There is the traditional one and then the Roth 401k plan. The biggest difference between the two is the tax liability. With a traditional 401k account, you don't have to pay taxes on the money that is put into your 401k account, while a Roth 401k account uses after tax dollars. So, when is the best time to pay taxes on that money? Really, it depends. If you expect to be in a much higher tax bracket when you retire, then it may be the case that it is better to go ahead and pay the tax when you are in a lower bracket. Honestly, it is a good idea to talk to a financial planner to find out what is the best decision for your personal situation.
The thing is, many employers match their employees contributions. This means that if you set aside, say 10% of your paycheck to automatically go into your 401k account, your employer will (depending on their plan) match at least a portion of that amount. If you think about, it is sort of like free money. For example, if your employer matches only the first 5%, and you contribute 10% or $100 each payday, your employer is throwing in an extra $50. You can see how this can add up.
401k plans can move with you when you change employers and you can even take a loan out against them. When you take a loan against your 401k, you will just have to pay yourself back at a low interest rate. So, for young people who don't plan on retiring soon, starting a 401k plan is still a great idea. Not only are you getting a head start on retirement, but you will be creating some real assets that you can tap into as your life progresses. Although it isn't the same thing as an emergency savings account, it can still help you out down the road.
Does your employer offer a 401k benefit? Have you enrolled in the program? Why or why not? I would love to hear your thoughts in the comments.
By Melissa Kennedy- Melissa is a 9 year blog veteran and a freelance writer for CollegeJobBankBlog. Along with helping others find the job of their dreams, she enjoys computer geekery, raising a teenager, supporting her local library, writing about herself in the third person and working on her next novel.