401k Savings : An Introduction Part 1


A Brief Introduction to the 401k

Hello Rookies!

For those that are employed, I’m sure you've heard the term 401k spoken of (at least during your HR orientation).  For those that have already begun contributing to their 401k, you’re already steps ahead!  For those that are not familiar with a 401k, or the reasons to fund one you’re headed on the right path! 

A 401k refers to a tax deductible retirement account sponsored by your employer. Your employer generally will match a portion of the amount of pre-tax dollars (your pay not yet taxed) that you contribute to the 401k account.  There are multiple benefits to having and utilizing a 401k.




What is a 401k?
“Tax deductible retirement account “ is the formal definition.   What that translates to is a type of saving/investment account that is intended for retirement savings. The savings come from your paycheck each pay period. Here are some of the great characteristics of 401k savings that distinguishes it : 

1-  money you put in is not subject to federal income tax  

A great way to cut the amount of taxes you pay to the government each pay period is to make a 401k contribution.  Let's say your pay check is for $1,000 and you fall into a 20% federal income tax rate.  Under this scenario you would pay $200 in federal income taxes (20% of $1,000) and take home $800 that actually goes into your hands (ignoring state, medicare, social security and other taxes for this example).  However, if you elected to put 20% percent of your paycheck into a 401k, $200 of that $1,000 would go toward your retirement savings leaving $800 that is subject to federal income tax resulting in $160 in federal income tax due (20% of 800), take home pay of $640 and retirement savings of $200.  The total amount of money you got to keep from that same $1,000 pay check totals to $840.  Congratulations, you took control of your own pay check!
The example above broken down: 
                                          No 401k Contribution                 20% 401k Contribution
  Pay Check                                                         $1,000                                     $1,000
 Pre-tax 401k deduction                                       $0                                             $200
 Federal taxes paid (assuming a 20% rate)          $200                                         $160
 Total money you got to keep                            $800                                         $840
                                        ($800 spending, $0 savings)                  ($640 bank, $200 savings)

But wait there is more....
2- your employer may match a portion of your savings = free money 
You chose to save 20% of your paycheck in a 401k retirement account resulting in $200 going into your 401k.  Your employer has also agreed to give you a 5% match on your contribution (this value is typically based on your gross income).  Based on the example above your employer gives you another $50 (5% of $1,000 pay) that also goes into your 401k retirement savings - your total now comes to $890!

                                                           No 401k Contribution                 20% 401k Contribution
  Pay Check                                                         $1,000                                      $1,000
 Pre-tax 401k deduction                                       $0                                             $200
 Federal taxes paid (assuming a 20% rate)         $200                                         $160
 Employer 401k 5% Match                                   $0                                             $50

 Total money you got to keep                            $800                                         $890
                                        ($800 spending, $0 savings)                  ($640 bank, $250 savings)

The money that you save in a 401k retirement account gets invested allowing it grow into more than what you originally put in.  You are quite literally planting the seeds of your future retirement.
Funding a 401k retirement account is an easy way to take control of your own paycheck by keeping more of it.  Don't allow your hard work to go to anyone else but you.  Take control of your paycheck and make it work best for you.



  

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