You have heard the term 401k before and know it has to do with retirement.
You may even contribute to a 401k, but do you fully understand it?
It’s simple to understand what it is and how it can help you.
Let me explain…
401k: The Breakdown
A 401k is a company retirement plan.
The name comes from the Internal Revenue Code:
Section 401, paragraph k.
Think of it like an IRA that is affiliated with your company. An IRA is individual and private, whereas a 401k is through a company.
Similar to an IRA, you (usually) have the option to invest in a Traditional 401k or a Roth 401k. A traditional 401k lets you contribute pre-tax dollars, but you will be taxed on the capital gains you earn. A Roth IRA lets you contribute post-taxed dollars, but you pay no tax on your capital gains.
The investment options will vary, depending on the retirement account provider, but you will usually be able to pick from a range of index funds and mutual funds.
With some companies you may even have more options, to include individual stocks and bonds.
Why Choose a 401k?
There is one main reason to choose a 401k over an IRA:
Free money.
Many companies will match what you put into a 401k, up to a certain percentage. Different companies match different amounts, but if they match at all, it’s free money.
You may also want to contribute to your 401k in addition to an IRA since the contribution limit for a 401k is much higher ($17,500 in comparison to $5,500 for an IRA – as of 2014).
However, if your company doesn’t offer a match and you aren’t able to contribute more than the limit for an IRA, I would suggest just sticking with your IRA since it will have more investment options.
You can also “catch up”, like you can with an IRA. Individuals over 50 can contribute an additional $5,500 per year to their 401k in order to help them reach their retirement goals.
Similar Plans, Different Names
A 403(b) is basically the 401(k) for organizations. 403(b) plans are only available to public education organizations, 501(c)(3) organizations, some hospitals and self-employed ministers.
A Thrift Savings Plan (TSP) is available to Federal employees, such as the military. Some Federal employees are offered a match and some aren’t. It depends on your position with the government.
The contribution limits and figures for 403(b) and TSP plans are the same as a 401(k).
A SEP IRA is a similar retirement account, but it is fully funded by the employer.
A Simple IRA is a company retirement plan for companies with less than 101 employees.
Contribution limits and other figures can change over the years. These numbers are current as of 2014. Get the current numbers here.
Final Words
I hope you feel a little more comfortable about 401k plans.
So, what should you do now?
- Figure out if your company has one of these plans.
- Contribute to your company plan if they offer a match.
- Contribute the maximum amount that your company will match.
- If your company doesn’t match, only contribute after you have maxed out your IRA.
- If you don’t understand something, ask questions in the comments.