Traditionally Americans have relied on Social Security to cover their expenses during retirement however as the fate of Social Security becomes uncertain many Americans have started to shoulder the responsibility of funding their own retirement. Many rely increasingly on their 401(k) retirement plans to provide the means to meet their income goals during retirement.
What is a 401(k) plan?
401(K) plans are tax-deferred retirement savings plans for employees. The employer sets them up and each company has a slightly different 401(K). They are part of a family of retirement plans known as “defined contribution” plans – the amount contributed is defined by the employer or the employee – for 2011 each employee can contribute up to $16,500 (individuals aged 50 and older could contribute additional $5,500 a year). There are several advantages to sock away money into 401(k) plan – primary ones are
- Tax deferral – A traditional 401(k) plan allows you to defer taxes on the portion of your salary contributed to the plan. Your taxable income is reduced by the amount you contribute, which in turn lowers your tax burden for the year.
- Compounding – Earnings generated produce a compound effect on your return on investments. As the earnings are also tax deferred, these earnings would generate more earnings over the years
- Employer match – In addition to its favorable tax treatment, one of the biggest advantages of a 401(k) plan is that employers may match part or all of the contributions you make to your plan. Typically, an employer will match a portion of your contributions, for example, 100% of your first 6%.
Like any good planner you have been contributing maximum to 401(k) plan and taking advantage of employer match, what else can you do to grow your wealth? The next logical step is to consider a Roth IRA.
