One of the many benefits of 401k retirement plans is the FREE MONEY (called "the match") available from most employers to employees who participate in their plans.
401k retirement savings plans are offered by many employers, sometimes instead of traditional pension plans. The employer typically hires a financial services company to manage the plan and the employee contributions and withdrawals.
Employees are offered the option to participate and can contribute from their earnings before taxes are calculated.
The Federal government sets limits on the amount employees can defer to their 401k plan.
In 2012, the maximum contribution allowed is $17,000. Workers 50 and over are allowed to contribute an additional $5500. Source: IRS website
401k retirement plans offered by employers are governed by Internal Revenue Service rules.
Employers can also contribute funds on behalf of employees since they may no longer provide funds to pension plans.
This contribution usually comes in the form of a matching contribution up to a certain level.
For example, an employer may offer to match dollar for dollar what the employee saves, up to 6 percent of the employee’s salary. The match amount can be lower, and may be reduced in tough economic times.
Married person, paid monthly
Salary $400 per week, $1600 per month before taxes and other deductions
Besides the employer match, there is another benefit to contributing to your 401k plan. The money saved in the 401k plans is not taxed (yet), and also reduces the amount of taxes the employee pays in total. During retirement, taxes are likely to be lower than they were while employed.
(Note:This fictional example only shows federal income taxes and does not include
social security or state income taxes for sake of simplicity.)
Not enrolled in 401k plan:
Federal income tax was $92.50 out of $1600.
Net Take Home Pay after taking out federal tax is $1507.50
Enrolled in 401k plan:
Contribute 6% to 401k, $96
$1600 - $96 = $1504 taxable amount
After 401k contribution, Federal income tax due $82.90
Net Take Home Pay after 401k deduction and Federal tax withholding is $1421.10
The difference in take home pay is only $86.40 instead of $96.
The combined 401k contribution of $192 ($96 from employee and $96 from employer) only cost $86.40 from the employee’s paycheck. That’s $105 in free money.
This results in over $2000 saved for retirement at a "cost" of $1036.80 for the year. At the end of the year, the 401k account balance could be even higher depending on performance of the investment portfolio.
In the event your family experiences unexpected challenges, it may be appropriate to take hardship withdrawals from your 401k.