A 401(k), name for the section of the Tax Code that governs them, is a Retirement Savings Plan sponsored by an Employer. It lets Employees save and invest a portion of their paycheck before taxes are taken out. Taxes are deferred until the money is withdrawn from the account.
With a 401(k), you control how your money is invested. Most plans offer a spread of mutual funds composed of stocks, bonds, and money market investments. The most popular option tends to be target-date funds, a combination of stocks and bonds that gradually become more conservative as you near retirement age.
While a 401(k) can’t force an Employee to save for their Retirement, it is a great way to save.
Most Plans include an Employer Match, so the Employee sees an immediate increase in value, as their dollars are “matched” by Employer Contributions. The most common Match is 3% of the Employee’s Annual Salary. Employees are advised to invest as much as possible, and at the very least, invest enough to get the full matching amount that the Employer pays.
The Employee saves the taxes that would have been deducted for the amount that they contribute. Based on a 25% Tax Rate, contributing $300 a month, only reduces your paycheck by $225.
The most you can contribute into your fund is $17,500 for 2013, and that increases $500 a year after that. If you’re older than 49, you can kick in another $5,500.
At the end of the day, there are few smarter decisions that an Employee can make than contributing as much as possible into their 401(k). Most smart Employees appreciate this, and a 401(k) Retirement Savings Plan is a fundamental part of attracting and retaining good employees.