Investing in 401(k)s

If you earn employment income from a
for-profit company,
you may have the option of putting money in a
401(k), a
retirement account that appreciates without taxation until
you retire or leave the company. (Not all companies sponsor
plans, especially small companies, and 401(k)s are not available
to state and municipal workers — check with your
employer to see if your company offers this plan.)

With a 401(k), the employee contributes pretax salary to the
plan. Generally, a 401(k) allows you to contribute a certain
percentage of your income each year to the plan.
Companies often match a portion of their employees’ contributions
to the 401(k). Many employers add 25 cents or
even 50 cents more to each dollar an employee chooses to
contribute. A typical formula is for an employer to match
50% of what an employee puts in, up to 6% of his or her
salary. The plan may also allow an employee to make aftertax
contributions.

Money that is contributed to the company’s 401(k) is then
invested in various, predetermined ways. Many plans typically
provide between four and seven investment options,
including mutual funds, stocks, and bonds. Usually, a plan
offers at least one stock fund, a balanced fund, a bond fund
or fixed income account, and maybe a money market
account.

Note that individual stocks and bonds are not allowed in
401(k) plans. One exception is the company’s own stock. For
example, General Motors employees can purchase that company’s
stock in the General Motors 401(k) plan.

The plan lets you decide which investments you want to put
your 401(k) money in. You can put all of your contribution
into one investment, or you can specify percentages of your
contribution to be invested in several of the investment
choices. This point is where you can face some risk — it’s up
to you to decide where to put your money.

Because your contributions to a 401(k) are excluded from
your reported income, they are tax-deferred from federal and
state income taxes. By using a 401(k), you get an immediate
tax deduction for your contribution. A third or more of the
average person’s 401(k) contribution represents money he or
she would have had to pay in federal and state taxes. The
beauty of the 401(k) is that the money gets to work for you,
rather than the government, in the years ahead. Plus, the
money grows over the years without taxation.


If you’re not already convinced that a
401(k) can be a great
investment, here are some other compelling benefits to consider:

 Many plans offer an automatic payroll deduction feature.
You never miss the money you contribute and payroll
deduction makes investing easier.
 Professionals manage the investment choices in most
plans.
 Most plans allow access to money in an emergency.
 Account services keep you informed with regular reports.
You may even have access to a toll-free number to call
for information.
 Your money can go with you from job to job. Even after
you leave your employer, you can roll your retirement
money into other tax-deferred retirement accounts, such
as an IRA.

Unlike a traditional pension plan (which promises a set dollar
figure in benefits when you retire), the amount of money
your 401(k) provides upon retirement is determined by how
much is invested and the way it grows. The regular account
statements you’ll receive offer an indication of your likely
return, but there’s no way to predict how much you’ll get
until the day you actually retire.

Deciding not to participate because you don’t want to cut
back on your take-home pay or telling yourself retirement is
a long way off may prove to be a big mistake. You risk ending
up without enough money after you retire.