A safe way to accumulate money for your retirement is via the 401(k) plan, which, by definition, is an employee-sponsored retirement plan with deferred tax benefits. You can use a special feature of this type of retirement saving account to get a 100% return on your contributions. Here are the details.
The 401(k) is a type of savings account that allows employee to contribute to the retirement fund of workers, along with the workers themselves. When you receive your salary at the end of the month, you can choose to send a portion of it directly to the 401(k) account. Your employer may offer a “matching feature” in which their contribution to your 401(k) match the amount you put in.
For instance, if you earn $12,000 per month, you may decide to put $1,000 into the 401(k) as your retirement savings, and take home the remaining $11,000. If your employer offers “401(k) matching”, the company will add another $1,000 to the account. That money is yours to keep! In other words, you get a 100% return on your savings, which is unheard of in the capital markets (i.e. stock and bond markets).
401(k) contribution cap
To prevent unfair use of this feature, there is a cap on the amount of money you can deposit in the 401(k) account. The maximum amount of money you can save through a 401(k) is $18,000 per year, according to Investopedia. This limit is higher if you are closer to retirement.
Similarly, employers may set a limit on the percentage of your income that they offer to match. They may match up to 3% or 110%, depending on their human resource policy and financial position. In all cases, the matching feature offers a 100% return on your contributions, so try to save as much as possible to gain full benefits of this retirement-friendly policy.
401(k) cash, stocks and taxes
Whether you choose to keep the money in cash form or invest it in mutual funds or other capital market instruments offered by your company’s broker, is entirely up to you. There is no right decision, because each option comes with a set of pros and cons, and your risk appetite will help determine what is right for you.
There are also tax considerations that impact the decision of how much money to place in the 401(k). In simple words, the funds you save are on a pre-tax basis, and will grow tax-free. You will, however, have to pay tax when you withdraw the money upon retirement or at some other point in your life (for which you may be penalized).
Have you set up a 401(k) account? What other ways are you planning for retirement? Please share below.