401k University

The Basics 

What is a 401k? 

A 401k is a savings plan provided by your employer.  You contribute to your 401k with money out of your salary and you decide how this money in your 401k is invested.

Why should I contribute to my 401k?

Your 401k plan is a savings vehicle for your retirement. Saving money in your 401k has tax advantages that are not available in a regular savings account for example. Many employers offer to match some of your own contributions into your 401k, in essence, giving you an indirect salary raise.

How much should I contribute?

You should contribute as much as your current financial situation allows you to. The more you save and contribute to your 401k now the more financially secure your retirement will be. If your employer offers a matching contribution then you should at least try to contribute the maximum amount your employer is willing to match.

What is the maximum amount I can contribute to my 401k?

The maximum amount is set by congress and changes every year based on inflation. For 2015 your maximum 401k contribution is $18,000. If you are 50 years or older, you can contribute an additional $6,000 for a total of $24,000.

What happens to my money in my 401k?

Money deposited in your 401k is invested in the investment options provided by your 401k plan. It is up to you to choose how the money is allocated in the various investment options available.

When and how can I access my money?

You always have immediate access to any money that you contributed out of your own salary. Money, or stock, contributed by your employer may be subject to vesting requirements which means it may have some conditions you have to meet before it can be fully yours. While you have access to some, or all funds, available in your 401k account, there is a 10% early withdrawal penalty associated with taking any money out of your 401k before you reach age 59 ½ (with few exceptions) in addition to you having to pay income taxes on any amount withdrawn.

My employer offers a regular 401k plan and a Roth 401k. Which one is right for me?

The main difference between a regular 401k and a Roth 401k is the way money contributed and withdrawn are taxed. In a regular 401k, the money contributed reduces your taxable salary and in effect reduces your current taxes but any money (and all gains on that money) withdrawn when you retire will be taxed. Contributions to a Roth 401k are after tax contributions – salary deferrals that you have paid taxes on- but future withdrawals in retirement are tax free.

Contributions to a regular 401k may be better for you if you are on a tight budget since you end up paying less tax at year-end which means you will have more money this year compared to a Roth 401k. However, if you are in a relatively low tax bracket today and expect that you will be in a higher tax bracket in the future then maybe a Roth 401k is better for you today. In short, the main choice you have to make is: Do I want to pay taxes now on money I contribute to my Roth 401k and get that money and any gains tax free when I retire or do I want to defer paying taxes on my regular 401k contributions today but pay taxes on that money and any gains once I make withdrawals at retirement?

Intermediate 401k – Things you should know

I am confused by all the investment choices in my 401k. Can you simply explain them?

They are indeed confusing and that’s why we launched 401k Tutor. The investment options in your 401k are primarily mutual funds that invest in different asset classes. You can think of an asset class as a uniform type of investment or an investment category. The major asset classes found in most 401k plans are basically domestic stock, domestic bond, international, and money market funds. Within stocks and bonds there are several sub categories. Some 401k plans offer one fund that broadly invests in each of the 4 asset classes above while other 401k plans offer a higher number of funds that include those broad categories as well as many subcategories. For stocks, there are funds that invest only in big companies; they are often referred to as Large Capitalization stocks or Large Cap for short. There are also funds that invest in medium sized companies (midcap stocks) and small companies (small cap stocks). There are also funds that invest in real estate via what is called a real estate investment trust or REIT for short. For bonds, there are funds that invest in US government bonds, also known as Treasury Bonds. There are also funds that invest in corporate bonds. For international funds, there are those funds that invest in developed markets -mature western economies - like those in Western Europe for example, and those that invest in Emerging markets – fast growing but often smaller economies.

What happens to my 401k when I leave my current employer?

When you leave your current employer your options are to either leave it where it is, move it to your new employer’s 401k plan (if they offer one), or transfer it to an IRA. Some 401k plans automatically disburse the money to you if your balance is less than $5,000.

Advanced 401k– How to Invest & Rebalance

How should I allocate my 401k among the investment options in my plan?

Since your 401k is intended to be a retirement fund, one major determinant as to how you should allocate your 401k depends on how far away are you from retirement age. Investment options in your 401k vary from those with low risk of fluctuation like Treasury Bonds (but lower potential long term returns) to those with much higher risk of fluctuation like domestic and international stocks (but higher potential long term returns). So you should allocate more money to asset classes that offer a higher potential long term return the further away you are from retirement since any near term fluctuation will be offset by the higher potential returns over a long period of time. Alternatively, the closer you are to retirement you should allocate your 401k money to asset classes that are more stable in value since you do not have a long period of time to offset any potential fluctuation if it happens in the near term. The other important factor to keep in mind when allocating your 401k is your attitude towards risk of loss and your financial ability to withstand potential losses. The less risk you can, or are able to take, the higher your allocation should be to relatively safer, less fluctuating asset classes.

Why and when should I rebalance my 401k?

Once you choose your 401k allocation today there will be 2 main reasons why you should rebalance or adjust that allocation in the future. The first is that as you get closer to retirement your investment choices should reflect that reality. Second, markets move up and down and the allocation percentages you chose last year have likely changed today because the various asset classes have changed in valueand you maybe today over or under-allocated to particular asset class. You should take a look at your 401k asset allocation at least once a year.

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