what is a 401k and how does it work a 401k is an employer-sponsored qualified
retirement savings account there are a few different types of 401k plans and
investment options can vary from employer to employer so there are three
main benefits of 401k plans first when you make deposits often called
contributions to your 401k plan well these contributions are made before
taxes are taken out this means that your federal taxable income that this year
will be lower and many times state taxes are also reduced
thanks to these contributions second your contributions grow without being
taxed this means that any taxes you would have paid on a typical investment
account can now be reinvested tax-free making the power of compounding work
even harder for you and third many times your company matches at least a portion
of the contributions you make to your 401k plan these three benefits make 401k
plans truly unique and powerful essentially you pay less taxes this year
your account gets to grow without taxes getting in the way and your employer may
give you essentially a retirement raise by often matching at least a portion of
what you put in one of the more popular forms of matching is for the employer to
contribute 50 cents for every dollar you contribute some companies even match
dollar-for-dollar now there are limits to traditional 401k contributions 2018
limits and 401k employee contributions went up from eighteen thousand dollars
in two thousand seventeen to eighteen thousand five hundred dollars in 2018
they call this a cost-of-living adjustment now just because it went up
in this example doesn't mean that it will go up every year the eighteen
thousand dollars from last year was in place since 2015 now this is the
employee contribution limit this does not take into account employer matching
the actual limitation for total contributions in 2018 was increased to
fifty-five thousand dollars from $54,000 in 2017 so we take the current total
contribution limit of fifty five thousand dollars and we subtract the
employee contribution limit of eighteen thousand five
and we see that there is room for another 36,500 this could come from
employer matching or maybe your company has some sort of profit sharing
contributions now there's also something called the ketchup contribution that
most 401k plans allow this ketchup contribution was put in place to allow
for baby boomers to catch up on their retirement savings in 2018 if you're
turning 50 within the calendar year you are eligible to contribute an additional
$6,000 to your 401k plan there are some nuances to this rule but broadly
speaking 6000 is the limit and that is on top of the 2018 limit of $55,000 so
should you contribute to your 401k plan and how much well knowing that every
situation is different and every employer is different the most accurate
answer is well it depends on your individual situation but broadly
speaking it makes sense for most people to contribute every year how much well
as much as I can going back to the three benefits we mentioned before well if a
company matches your contributions well you want to get as much of that money as
possible here's an example if you had zero in your 401k right now and you were
going to contribute the eighteen thousand five hundred uh limit every
year for the next twenty five years assuming the limit never went up and
that money was going to grow by let's say five percent per year
well at the end of the twenty five years your accountant be worth a bit over nine
hundred and twenty seven thousand dollars but if your employer put in just
50 cents for every dollar you put in all else being the same your account would
now be worth about one point three nine million that's more than a four hundred
and sixty thousand dollar difference so if it's being offered to you why
wouldn't you take it now let's imagine that your employer doesn't match it all
well the fact that your yearly taxable income is lowered and you get to invest
that money without worrying about tax is getting in the way well once again it's
free money why not take it so what is your 401k investing once again this
depends on your employer oftentimes you'll see a few investment options you
might see equity funds which invest in stocks bond funds which you may have
guessed invest in bonds balanced funds this is usually a combo of both stocks
bonds and sometimes cash international funds perhaps they offer emerging
markets or developed markets generally each fund will describe their offering
what invest in and oftentimes the general
risk level will be spelled out for you generally it makes sense to consider how
long you're going to be investing in the account and then choose the investments
accordingly if you have any questions about the world of investing any
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