What is a 401k and why do you need one?

By Catalogs Editorial Staff

Do you know what a 401k is and why you really need one?

To understand what a 401k is, you need to learn the basics of this popular investment and retirement tool and why it might be right for you. Most experts agree that you should start think about retirement as early as your mid-twenties.

With all the economic uncertainty that many of us face on an individual and collective basis, it is more important now than ever to be proactive and build a financial safety net. Here is a quick rundown of what a 401k retirement plan is:

It is a Savings Plan Offered by Many Employers

Typically, a 401k is offered as a savings plan that is now a part of a lot of employment benefits packages. 401k retirement plans began as supplements to pensions and are named for the tax code that governs them.

In a nutshell, 401k plans allow you to put money into a retirement fund before taxes are withdrawn from your paycheck. You are only required to pay taxes when you withdraw from you 401k account. In recent years, 401k accounts have come to replace pensions in most industries.

401ks Allow You to Control Your Investment

Most banks who facilitate 401k accounts offer a wide variety of investment plans involving various types of mutual funds. These mutual funds have differing levels of investment in respect to stocks, bonds and regular market investments. What options are available you depend on factors like your income level and 401k servicer.

There Are Some Restrictions

For example, sometimes an employer will try to incentivize prospective employees by offering to match 401k contributions up to a certain amount. Usually, these contributions are dependent on your employment lasting a certain length of time and therefore cannot be withdrawn early.

As with most retirement accounts there is a penalty fee for withdrawing from a 401k before retirement age or the length of time agreed upon when the account is opened.

Your access to these funds might be limited if your employer runs into financial trouble and if the company goes under your account will probably be closed.

Roth 401k

The Roth 401k is a little different than the traditional 401k in that taxes are taken out before the money is deposited into your account. With a Roth 401k you do not have to pay taxes upon your withdrawing from the account.

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