A 401K is a long term savings plan that is designed to accumulate money towards retirement. It is so-named after the section of the US Internal Revenue laws that allow this particular kind of financial planning option. These plans are typically only available through an employer; the money is generally taken out of the employee’s paycheck every week or month and deposited in the account.
An employee chooses the amount she wants taken from her check every payday to contribute to the plan. This money is then invested in such things as money market funds, growth funds, and index based stock funds, which will accumulate value over time. The maximum pre-tax amount an employee can contribute to the plan varies by year, although the amount is generally around $16,000 US Dollars (USD).
401k plans are generally safe and effective, although there are some risks as with any financial plan; if money is put in to certain more risky investments, the account may not grow as quickly as anticipated. The funds are not protected by the Pension Benefit Guaranty Corporation (PBGC) which safeguards the assets of most other pension plans.
One of the biggest
advantages of a 401K is that many employers will typically match employee contributions. If an employee decides to contribute 10% of her salary every month towards her plan, her employer may choose to match this and contribute the same dollar amount itself. Employers are not obligated to match contributions, but almost 80% of companies do to some extent.
These plans have several other advantages: they are fairly easy to understand and participate in, they often offer many different investment options, and a person can choose to invest in safe or risky options. Many also allow the participant to change not only the percentage of her salary she is contributing, but also the investments that she is allocating money to.
An employee may also borrow money from a plan account. A 401K loan does not appear on a credit report, and there is no restriction on what the money can be used for. There may be charges and fees involved in taking out the loan, however, and an employee also loses out on any employer matching contributions while paying off the loan. There is often a minimum loan amount of $1,000 USD.