A 401(k) plan can offer many advantages such as free money from your employer, lower taxable income, and savings that accumulate without you making deposits. In 1978, Congress decided to encourage Americans to save more money for retirement while lowering their state and federal taxes. The resulting Tax Reform Act authorized the creation of a tax-deferred savings plan for employees. The first 401(k) plan was available in 1982. It is really a “defined contribution” plan where the employer or employee put a set amount of money into the fund.
There are four unique attributes to the 401(k) plan.
You decide to put up to 15 percent of your monthly salary into your plan, but the employer can limit that amount. The IRS limits the total annual contribution to $11,000.
The money contributed is taken before taxes, so you never have a chance to see it.
Many employers match a portion of your contribution to entice you to participate.
A third party takes the money and invests it in a mix of mutual funds, bonds, money market accounts, etc. determined by the amount of risk you are willing to take.
The downside of a 401(k) plan is that if you withdraw money before you are 59.5 years old, you have to pay a 10 percent penalty fine to the IRS and pay taxes on the money you receive.
If you start saving at 25, you can have over a million saved by the time you are ready to retire! Your money is safe in a 401(k) no matter what happens to your employer thanks to the Employment Retirement Income Security Act of 1974.