6 Things to Know Before Investing in a 401(k)

By January 15, 2016Budgeting, Personal Finance

While retirement may seem eons away, it’s never too early to start funding a retirement account. Parting with part of your paycheck each payday may be hard to swallow, retirement accounts offer many benefits outside of funding your future retirement.

Retirement accounts offer many benefits, but there is a downside as well. Here are 8 things you need to know before investing in retirement accounts:

  1. Tax Breaks

Putting money towards retirement while young allows your investments time to mature and for you to earn returns. You can decide to put money away in a savings account, but other options provide tax shelters. Investing in a 401(k), IRA or other dedicated retirement account provides a tax shelter that boosts your annual return.

  1. Employer Match

Many companies offer 401(k) plans where the employer matches the contribution of the employee. Forbes reports that the majority of large companies will match an employee’s investment, while only two thirds of small companies do. Make sure to review and understand your 401(k) contribution vs what your employer will invest prior to signing.

  1. Early Withdrawal Penalties

Deciding what amount to invest in a retirement account can be challenging. Life offers many surprises that come with unexpected expenses. You may have chosen to allocate a certain amount of funds from your pay to retirement leading to a large sum of money that you may need for future expenses. If you do need to access your retirement savings before the age of 59.5 you’ll most likely be subject to a 10% penalty on previously untaxed funds, contributions and earnings.  There are exceptions to this. As Forbes reported, you can pay for college or grad school penalty free with funds from and IRA account but not from a 401(k).

  1. Flexibility

If you’re looking for flexibility with your retirement account look into a Roth IRA. Legally you are able to contribute up to $5,500 a year in post taxed earnings to a Roth IRA. If you’re over the age of 50 your contribution maximum increases to $6,500. Your investment will grow tax free towards your retirement, and you can take back your initial contribution at any time for any reason without taxes or penalties. Forbes suggests investing enough in your 401(k) to receive a full employer match then fund a Roth IRA next.

  1. Bad 401(k)s

Not all 401(k)s are a good investment. Some 401(k)s have high administrative and investment expenses. According to an annual survey conducted by BrightScope, the most expensive 401(k)s – traditionally small plans – cost 1.53% or more of a worker’s contribution each year. Compare your 401(k) at BrightScope.com.

  1. Switching Jobs

It’s very common to switch jobs before retirement. When leaving a company make sure to role your 401(k) to an IRA on your new employer’s 401(k). This is called an institution to institution transfer. Withdrawing the funds from your existing 401(k) would be a mistake, since it would result in taxes and a 10% penalty fee. If you have a retirement account worth less than $5,000 your former employer could transfer your funds to an IRA with high fees and a negligible returns.

Investing in your retirement is an important and vital decision. Review all your options before investing. Was this article helpful? How do you plan to invest in your retirement? Let us know in the comment section below.

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