Investing in 401(k)s

If you earn employment income from a for-profit company, you may have the option of putting money in a 401(k), a retirement account that appreciates without taxation until you retire or leave the company. (Not all companies sponsor plans, especially small companies, and 401(k)s are not available to state and municipal workers — check with your employer to see if your company offers this plan.) With a 401(k), the employee contributes pretax salary to the plan. Generally, a 401(k) allows you to contribute a certain percentage of your income each year to the plan. Companies often match a portion of their employees’ contributions to the 401(k). Many employers add 25 cents or even 50 cents more to each dollar an employee chooses to contribute. A typical formula is for an employer to match 50% of what an employee puts in, up to 6% of his or her salary. The plan may also allow an employee to make after tax contributions.
Money that is contributed to the company’s 401(k) is then invested in various, predetermined ways. Many plans typically provide between four and seven investment options, including mutual funds, stocks, and bonds. Usually, a plan offers at least one stock fund, a balanced fund, a bond fund or fixed income account, and maybe a money market account.
Note that individual stocks and bonds are not allowed in 401(k) plans. One exception is the company’s own stock. For example, General Motors employees can purchase that company’s stock in the General Motors 401(k) plan. The plan lets you decide which investments you want to put your 401(k) money in. You can put all of your contribution into one investment, or you can specify percentages of your contribution to be invested in several of the investment choices. This point is where you can face some risk — it’s up to you to decide where to put your money. Because your contributions to a 401(k) are excluded from your reported income, they are tax-deferred from federal and state income taxes. By using a 401(k), you get an immediate tax deduction for your contribution. A third or more of the average person’s 401(k) contribution represents money he or she would have had to pay in federal and state taxes. The beauty of the 401(k) is that the money gets to work for you, rather than the government, in the years ahead. Plus, the money grows over the years without taxation.
If you’re not already convinced that a 401(k) can be a great investment, here are some other compelling benefits to consider:

• Many plans offer an automatic payroll deduction feature You never miss the money you contribute and payroll deduction makes investing easier.
• Professionals manage the investment choices in most plans.
• Most plans allow access to money in an emergency.
• Account services keep you informed with regular reports. You may even have access to a toll-free number to call for information.
• Your money can go with you from job to job. Even after you leave your employer, you can roll your retirement money into other tax-deferred retirement accounts, such as an IRA.

Unlike a traditional pension plan (which promises a set dollar figure in benefits when you retire), the amount of money your 401(k) provides upon retirement is determined by how much is invested and the way it grows. The regular account statements you’ll receive offer an indication of your likely return, but there’s no way to predict how much you’ll get until the day you actually retire.
Deciding not to participate because you don’t want to cut back on your take-home pay or telling yourself retirement is a long way off may prove to be a big mistake. You risk ending up without enough money after you retire.