Free money from your employer can be termed as one thing — a 401K plan. This is an employer sponsored retirement plan where employees contribute a percentage of their salary into an account, with employers providing a matching percentage.
Motley Fool describes it as “one of the best ways to save for your retirement. Few alternatives are better.”
Basically your contribution is automatically taken from your paycheck before taxes. These contributions along with any match that your employer may or may not provide are invested into selected funds. The funds will grow without being taxed and can be withdrawn when you reach age 59 ½. At that time you must pay income tax on the withdrawal. Some plans will allow you to withdraw the money before age 59 ½ without a penalty to buy a home or to pay for education.
401K plans are grouped into two categories, defined benefit and defined contribution. With a defined benefit plan, employers vow to pay a specific amount to eligible retirees. It’s based on a formula of earnings and years of service, and employees can usually predict their monthly retirement income.
A defined contribution plan uses a formula of employee and employer contributions and the condition of the market to determine a retiree’s income. In this case even though an employee contributes say 5 percent of their salary into a plan and the employer contributes 10 percent, there is still no definite number for what the employee’s monthly retirement income will be. The state of the market will be the final determining factor.
The number one reason for participating in a 401 K plan is that it makes saving and investing easy. Since the money is automatically taken from your pay check, you don’t see or miss the money. For the new investor, you can choose what funds to invest or your employer can choose for you, but the options are prescreened, minimizing the risk.
Getting the most from your money
Once you’ve decided to participate, be sure to contribute the maximum you can afford and that’s allowable or at least contribute the amount necessary to get the company matching funds. It’s a payment to yourself. The earlier you start this, the more money you will accumulate at retirement because you will have time to recoup from market fluctuations.
And don’t leave it all up to your employer. Do your homework, learn about the funds offered, and keep researching them so you can be ready to rebalance your plan if necessary.
Yes, you’ll need to rebalance on a regular basis. Always reassess your goals and risk factors then look at your investments to see if they are in line with what you want. If not, companies have open enrollment yearly and at that time talk to a plan sponsor on finding new investments that work for you.