What should you know about 401k?

There are several different benefits in 401k, but first of all lets define the meaning of 401k. This type of program allows an individual to reduce their taxable income due to the fact that the money comes out from your employer of your pay before taxes are taken out. Therefore, your money is saved tax-free as opposed to getting taxed on it yearly.

Some of the other top things you should know about 401k is the federal limit on annual pre-tax contributions continues to rise. If you feel that you cannot afford to max out your 401k, you can make a contribution which is just enough to get ‘free money’. A typical contribution is about 50 cents on the dollar, up to 6% of salary you are getting. Before retirement, taking out of your 401k plan can be quite expensive. For example, if you are of age 59 ½ and decide to withdraw some money out, you will have to pay income taxes and an additional penalty of 10%. Therefore this is not a good solution.

When you are ready to setup a 401k account, you should do the math and figure out what your combination of bonds and stocks should be. This decision is primarily based on risk tolerance and the time period until retirement. You should also keep your choices simple when investing especially when you’re limited to the 401(k) your employer chooses.

So what happens with your 401k when you change jobs?

Usually, there are 3 options when switching jobs:

1. You can leave the 401k money and not move it at all.

2. Move it over to an IRA or another different 401(k)

3. Cash Out

Lets say for example, you have less then $5,000 in your 401k account. Your employer might suggest that you take your cash out of your account in that situation, however you must know that cashing out is almost like shooting yourself in the foot finance-wise. Small accounts do have the potential to grow over a period of time. Your best option might be to just roll the $ out into another type of retirement account. When rolling money into a 401(k) or an IRA, you must make it payable to “trustee-to-trustee” to avoid the risks of penalties in case the execution of the rollover fails.

Know the rules

You should find out all the rules from your employer if there are any that exist. If no rules are present, your money can be left alone until you are of age 70 ½. This is the age when Uncle Sam suggests that all retired individuals start withdrawing Monday from their 401k and IRA plans.

Source: http://money.cnn.com/