Personal Finance Tip of the Day

Handy Personal Finance
ISBN: 9781578593224

What is a 401k Plan, and why is it great?

  • It allows companies and employees to cooperate to save money.
  • It can grow with compounding interest.
  • It can protect your income from taxes.
  • It can help you save steadily for retirement.

It is a corporate retirement plan which allow for employees to set aside a certain percentage of their income, tax deferred up to a limit, and withdraw from this account when they retire. It also allows companies to match a certain percentage of the employees' income up to a limit, and also contribute to the account.

Because of the compounding of investment returns over time, you have the ability to grow your account tax free, over the long term. You don't have to pay taxes on the amount of income earned that you contribute into your 401k, so it is a way of shielding your income from taxes. Since you will most likely be making more money now, and paying more in taxes now, than when you retire, when you do begin to withdraw from your 401k, it will be taxed at the rates that your income bracket will be when you are earning much less, thus allowing you to pay less taxes on that money in the future than you would be paying on it today, if you didn't invest in your 401k. So you get retirement savings, company matches, tax deferrals, and tax free earnings just by deducting a small percentage of your income each year.

From The Handy Personal Finance Answer Book by Paul A. Tucci, (c) 2012 Visible Ink Press(R) Answers to more than 1,000 answers to questions on personal finance, its history, and managing one's financial life.
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