How You Benefit From a 401k

The most important benefits of a 401k retirement plan relate to taxes. No tax has to be paid on the money placed in a 401k until it is withdrawn during retirement. There is also no need to report the money that is paid into the 401k to the IRS, so your taxable income will be reduced. This can result in substantial savings.

A 401k can be an excellent way of saving for retirement because the compound interest can help the money placed in the plan to grow rapidly. To understand the benefits of a 401k, it is useful to compare it to a taxable investment portfolio.

If an individual was able to invest 10,000 dollars a year into either a 401k or a taxable portfolio, then they would end up with more money if they chose the 401k. Assuming the money in the 401k was all invested into index funds, and so achieved the market return average, usually 10 percent, then their money will have increased to over 1.6 million dollars in thirty years, even if their employer is not making any matched contributions. The same money, invested into a portfolio which might be taxed at about 24 percent would only have grown to just over 1 million dollars. This means that by investing in the 401k, the individual could save 56 percent more than if they chose a taxable portfolio.

A 401k can be a very wise investment as long as you are committed to taking full advantage of the plan and your employer provides a range of different investment choices. Most employers offer the option of having contributions to a 401k automatically deducted from your paycheck. This simplifies saving for your retirement and means that the reduction in taxable income will automatically be taken into account. It also ensures that the money is saved by removing the temptation to spend it. This can be very useful because 80 percent of people in the US do not save any of their regular wages.

The tax benefits of a 401k also ensure that your income is not reduced by as much as if you saved the same amount elsewhere. If you make the contributions into your savings before you pay tax, by investing in a 401k, then you will not be paying any tax on this saved money. If you wait until after tax has been paid then you will be paying tax for your whole income, including the money you will be placing into your savings, and then taking out your contribution, leaving you with less currently available money.

Related posts:

1. The History of the 401k
2. The 401k Employee Retirement Plan
3. Discrimination Testing for 401k Retirement Plans
4. Individual Retirement Accounts (IRAs) and Other Retirement Plans
5. Tips for Employee Retirement Plans

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