One of the most common terms to encounter when thinking about retirement planning is 401k. Many laud the tool as a great way to help save for retirement without getting nailed by taxes. While this can be true, many people are forced to consult professional planners in order to properly set up and use a 401k plan because the entire area can be so confusing to those who have not studied it thoroughly.
In fact, as much as the phrase “401k” gets used, some people don’t even really know what such a plan is. If you’re looking to grasp the basics of 401k planning, look no further! Check out these 6 pointers that comprise the essentials of constructing and maintaining a 401k plan.
What is a 401k plan?
A 401k plan is, simply put, a way for employees to defer paying taxes on their income. By contributing money toward retirement through a 401k, income taxes are not paid on contributions until they are withdrawn, meaning that the employee does not have to pay levies on that money immediately. Usually, 401k plans are run by employers for their workers, meaning that such a program is internally linked to a job. By contributing to a 401k, you can stand to save significant amounts of money in taxes compared to traditional retirement plans. The funds can then be accessed once you are 59 and a half years old.
How do you start a 401k plan?
Usually, the most common way is to talk to your employer and see what options are available. Generally speaking, the folks in accounting and payroll will be knowledgeable about such operations. If you’re new or you’re concerned about transferring money into a 401k, talk to them about various rollover plans that can incorporate existing savings and create a comprehensive plan for your retirement. Speaking with a private retirement planner can also be an option, though it can get pricy depending on who you want to talk to.
How much can you put in a 401k plan?
The maximum contribution for a 401k plan was raised in 2013 to $17,500 per year; however, by no means should you necessarily put that much into your plan. The usual recommendation for savings is approximately 12 percent of your income, but that number can change depending on your circumstances, your income, and yearly factors. Generally speaking, making sure that you are trying to contribute at least 10 percent of your income each year is a good place to start. Be aware that some employers will match certain amounts of contributions; if possible, take advantage of such opportunities to pick up free money for your old age.
What assets are in a 401k plan?
All of the usual suspects can be part of a 401k — mutual funds, bonds, stocks, real estate, and other assets that are widely held for long-term value. Keep in mind that a 401k is a marathon and not a sprint (over 400 kilmoters is a long distance). That means that diversification is the key to taking advantage of positive trends in the marketplace without succumbing to variance or volatility. Having some up years and some down years is okay if overall you can end up ahead, which is essential with retirement savings. Diversification also helps to insure that you won’t get wiped out if one sector collapses.
What steps should be taken to maintain a 401k plan?
One of the nice things about 401k plans is that they largely look after yourselves. Your 401k plan is not the place to be speculating; thus, you shouldn’t be on your phone every hour checking how your retirement account is doing because of ups and downs in the stock market. However, it’s a good idea to keep your 401k balanced, meaning that you readjust your positions to conform to your ideal, diversified distribution. If you started with half stocks and half bonds, for example, and your stocks did very well, you could very well have 60 percent in stocks by the year’s end. In that case, you should sell some stocks and put more money in bonds to preserve the original 50/50 balance.
What new changes are happening with 401k plans?
Another nice thing about 401k plans is that it’s hard for the laws around them to change drastically because so many people would be impacted. Next year, there will be a new tax credit for individuals and couples who earn below $30,000 per person if they are contributing to a 401k plan (check out this synopsis for the exact details). Just starting this year was the $17,500 cap on contributions, up $500 from 2012.