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401k benefits

Blog: 8 401(k) Benefits You Should Know About

There are many benefits of 401(k) plans, and some are less known than others. A 401(k) is a type of retirement plan offered by an employer in which the employee can defer part of their paycheck into a retirement account to grow for their retirement years. Many people have access to a 401(k) retirement plan. 401(k) accounts have limits on what the employee can add, and the total that can be contributed to the account during each tax year. Now let’s get into some 401(k) benefits you may not know about. 


What is a 401(k) plan? 

A 401(k) is a retirement savings and investment plan that some employers offer to employees. Employers can offer a 401(k) as part of their benefits package where an employee can contribute a portion on their paycheck to their 401(k) and then the employer may match a portion of the employee’s contribution.  The annual contribution limit for a 401(k) for 2021 is $19,500 ($26,000 for those age 50 or older). If you are self-employed with no employees, then you can have a similar account called a Solo 401(k).

1: 401(k) tax benefits

One of the major benefits to using a retirement account to save for retirement (rather than a taxable account), is that retirement plans have tax benefits that taxable accounts do not have. All 401(k) plans allow employees to save on a pre-tax (traditional) basis, and many also give the option for you to save on an after-tax (Roth) basis. 

If you choose to contribute your money into a traditional 401(k), the contributions are tax-deferred. This means it will lower your current taxable income now, and the money is added to your 401(k) account on a pre-tax basis (no income taxes have been paid on them yet). This money will grow tax-deferred until you withdraw the funds in retirement. At that time, you will pay income taxes on the money you saved, as well as the growth, as you withdraw the funds. 

Alternatively, Roth 401(k) money is post-tax money. You pay regular income taxes on your paycheck now, before adding the funds to a Roth account. The money in the Roth 401(k) account then grows tax-free. When you withdraw this money in retirement, you will not pay any income taxes on the funds you withdraw! 

Either way you go, you are getting a tax benefit. You are either saving on taxes now or later. Read our blog about Roth 401(k) vs Traditional 401(k) to learn more about each option and decide which is best for you. 


2: 401(k) match benefits

Many employers will also offer a 401(k) match. What this means is that the employer matches your contributions up to a certain percentage of your salary. If you put that percentage in, the employer adds the same amount to your 401(k) for you out of their pocket. FREE money alert! 

The match may look something like this: “Employer will match 50% of employee contribution up to 7% of salary.” This means that you need to put 7% of your salary aside into your 401(k) to receive the full match, which will equal 3.5% (half of your contribution) of your salary. It may also say something like this: “Employer will match 100% of employee contribution up to 5% of salary.” This means you put 5%, and so does the employer. These matches can have many different variations, but any type of match or flat contribution is free money into your account! 


3: If you change jobs, you can take your 401(k) with you.

It is a common misconception that if you leave a job, you need to cash out your 401(k) or lose it. There are actually a few options for those who leave jobs and have a 401(k) with the company they’re leaving. Some options may include rolling it into your new 401(k) plan, leaving it with the old 401(k) plan, and simply managing the investments, or rolling it into an IRA. 

Avoiding cashing out your 401(k) when you leave a job is important. This is your savings for retirement, and cashing it out will stop the growth and undo all of the hard work you did to put the money there in the first place. There are many options for what to do with your 401(k) when you leave a job. 


4: 401(k) compound interest benefit

In the last example, I said cashing out the 401(k) will stop the growth. What I am talking about is this: compound interest. Compound interest is the interest you earn on your money, which compounds when that money starts earning interest on the previously earned interest. It might sound confusing, but it really is powerful. The younger you start to save for retirement, the more time your money has to grow. Compounding can have a big impact on long-term investment and your retirement portfolio will be made up of compound interest.

You can use a simple compound interest calculator like this to see what the value of your money might be when you retire. Using this calculator, $5,000 saved at age 25 and left to grow at a rate of 6% for 40 years (assuming age 65 for retirement), would be worth over $68,000 at age 65! That means 93% of that portfolio is all compound interest on the initial $5,000 investment! Now imagine if you added $5,000 every year to that account. 

The younger you start saving for retirement, the longer your money has to compound. Things like what you invest in and fees can make a difference, so ensure you know your options before deciding on your 401(k) investment portfolio.

Visit District Capital Management to find out the other four 401(k) benefits you should know about. 

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Alvin Carlos, CFA, CFP®

About Alvin Carlos, CFA, CFP®

Alvin Carlos, CFA, CFP® is passionate about helping middle class professionals make smarter financial decisions. He is the CEO of District Capital Management, a financial planning and investment management firm for the everyday people. Alvin is a CERTIFIED FINANCIAL PLANNER™ practitioner and has a Masters degree in International Relations from SAIS-Johns Hopkins. In his spare time, Alvin enjoys swing dancing and Ultimate Frisbee. He also volunteers for Catholic Charities’ new Financial Stability Network, which helps low-income folks with their finances.


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