Take Advantage of Your Company's 401(k) Plan
To help employees save for retirement, employers often offer a 401(k) plan through which employees can make tax-deferred contributions toward their retirement savings. However, too many employees don't take full advantage of their 401(k) plan, and those who do must be sure not to sabotage their retirement planning by tapping into it to meet random cash-flow needs.
- How much to contribute. Many experts say you should consider contributing between 10% and 20% of your income to your 401(k). If you can't afford that much, contribute what you can. And if your employer offers a matching contribution, try to contribute enough to take advantage of the match.
- Tax advantages. Contributions to a 401(k) are made in pre-tax dollars, so they reduce your taxable income. If your employer offers a Roth 401(k), you may want to consider that. Contributions are made in after-tax dollars, but qualified withdrawals are income tax-free. How to decide? One factor is whether you think you will be in a higher or lower income tax bracket when you retire.
- When to begin saving. No matter how old you are, you should be contributing to your 401(k). And the younger you are, the more your savings will build over your lifetime. If you're 50 or older and are concerned that you won't have the money you need, you can make catch-up contributions—an extra $5,000 a year—as long as your employer doesn't have contribution limits.
- How to invest 401(k) contributions. Most plans offer a diversified array of investment options, from conservative to aggressive. Financial experts agree that "asset allocation"—spreading your money across different types of investments—is a good approach. When making decisions, consider your age, how close you are to retirement, your financial goals, and your risk tolerance. The company that administers your plan may offer interactive tools and worksheets, but if you prefer, a licensed financial professional can help. There is no guarantee that asset allocation will ensure a profit or protect your investment against losses in declining markets.
- Penalties for early withdrawals. Avoid tapping into your 401(k) to meet immediate cash-flow needs, pay off debt, or cover emergencies. The penalty for early distribution from a 401(k) is considerable. The withdrawal amount generally is included as part of your taxable income plus a 10% additional tax penalty fee applies if you are under age 59 1/2 unless an exception applies. If the taxation exceeds the interest penalty on your debt, the money you lose should make you rethink chipping away at one of your greatest sources for retirement income.
- Rolling over your 401(k). If you leave your employer, you can roll over the vested portion (the part you contributed plus the company match to which you are eligible after a certain number of years of service) of your 401(k) into an individual retirement account so that you can continue to save for your retirement.
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The Prudential Insurance Company of America, Newark, NJ