Understanding Your 401(k)
A large part of your retirement income may come from your own savings, including your 401(k) plan. That’s why it’s important to understand how your plan works and the advantages it offers. Understanding the basics can help you better prepare for a comfortable retirement.
The 401(k) – what is it?
A 401(k) is a retirement plan sponsored by your company. You typically decide what percent of your income you want to contribute to the plan. There is a limit on how much you can contribute each year. The limit is indexed for inflation, so it usually increases annually.
Your contributions are taken out of your paycheck before income taxes are withheld. That means you’ll save more in the plan than you’ll give up in your paycheck. For example, if your effective tax rate is 25%, you’ll save 25 cents in taxes for every dollar you invest in the plan, so your out-of-pocket cost is just 75 cents.
You’ll pay the taxes when you withdraw the money, but...
- You may be in a lower tax bracket when you begin withdrawals
- There are significant growth advantages due to compounding
The money that your contributions earn is also tax-deferred. Taxes won’t be due until you start receiving money from the plan, usually at retirement.
401(k) Investing fundamentals
When setting up your 401(k), your employer made a decision about the investment options in the plan. Your contributions and employer matching money (if any) are either managed by investment professionals or you choose your investments from a group of mutual funds and/or company stock. Most often, employers allow employees the option to select their own investments. But if you don’t know much about investing, it can be hard to know where to start. Here are a few guidelines that might help:
- Anticipate your needs
To afford the retirement lifestyle you’ve always wanted, you need to save enough money. But how much is enough?
A practical starting point is to figure out what you’ll need and want during retirement and what amount of income will sustain that lifestyle. Break down your future income sources into categories. Include estimated Social Security payments and benefits from any pension plans sponsored by your employer, income you’ll draw from your personal saving and investments, and funds in your 401(k).
- Identify and set goals
Choose a realistic goal for your retirement account balance and then commit yourself to reaching it before you retire. Bear in mind that the earlier you make your contributions, the longer they can take advantage of potential tax-deferred growth. Contributing more now may significantly increase the size of your retirement nest egg by the time you need to begin withdrawing funds.
- Go for it
Regardless of how close you are to retirement, it’s important to set attainable goals and expectations. Take the time to estimate the amount of retirement income you’ll need and set a targeted 401(k) account balance. Then, contribute as much as you can to reach that target amount.
- Diversify your investments
Most retirement planners advise the use of a diversified approach, with some investments in conservative investment options and others in both moderate and more aggressive options. Diversification is especially important if you hold employer stock through your plan. Periodically, you should reexamine your investment diversification and make changes according to your stage of life.
Take our risk tolerance quiz for a mix of investments that might work for you.
When investing for long-term goals, keeping an eye on asset allocation is critical. Over time, investment gains or losses can cause your portfolio’s allocation to become unbalanced. When this happens, the portfolio may become more aggressive or more conservative than originally intended. Be sure to review your asset allocation at least annually to make sure you’re still on target for your asset allocation.
Changing jobs – what it means to your 401(k)
Landing a new job is exciting, and you have a lot to think about as you prepare to leave one employer for another. One of the decisions you’ll have to make is what to do with your 401(k) money – remember, that’s your money.
We can help you look at all the options. Check out the many products and services available to meet your retirement planning needs, or find a COUNTRY Financial representative near you for personalized help.
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