25 years ago, few people had ever heard of a 401(k) plan. Today it’s a household word, like 409 spray or WD-40. Employees have come to expect a good 401(k) plan when they take a job, and employers know they must offer them to attract the best workers.
With a 401(k) plan, an account is established for each participating employee. The employee makes fixed contributions to the plan–generally a percentage of each paycheck. The employer may match that amount, with a dollar for dollar or $.50 per dollar contribution, up to a certain percentage.
For example: You contribute 10% of your salary, which means 10% of each paycheck. Your employer matches each dollar up to 3% of each paycheck. Say you make $35,000 per year, so you contribute $3,500 a year, or approximately $135 per pay period ($3,500 divided by 26 paychecks per year). Your employer will match about $40 per pay period (3%). Altogether, the total contribution to your account per month will be approximately $350.
Other advantages of 401(k) plans include:
- In theory, you may contribute up to 15% of your salary (many plans limit this number and each year the government places a maximum cap on contributions).
- Various investment options to self-direct your retirement investment.
- Tax deferral on gains until money is withdrawn.
- Professional money management.
- The ability to transfer the vested balance to a new employer for continued growth.
- In many cases, the ability to borrow up to 50% of your account’s balance.
The downside to 401(k) plans is that–like all plans designed for retirement savings–withdrawals made before age 59 ½ may be subject to a 10% federal tax penalty.