I'm still baffled by 401(k)

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Thread: I'm still baffled by 401(k)

  1. #1
    Senior Member Array taseal's Avatar
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    I'm still baffled by 401(k)

    Can someone like 'dumb' this down for me?

    I thought it was just like a savings account that your company that you work for pitches in as well...

    I put in 5% into it, and my company gives 125% of what I give. pretty good I guess... however, as i'm looking at my account I see that it's almost like a stock. it kind of goes up and down etc...

    how does it work? the wiki article had me confused

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    Your money is put into stocks, bonds and mutual funds.... So as the market goes up and down, so will your 401k. It only really matters when you cash out....
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    Senior Member Array Jackle1886's Avatar
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    Your 401(k) (or a,b) is made up of money you put in, and money that is matched by your company. This money is used to buy mutual funds, stocks, bonds, etc. Generally you are also given company stock, whether it be public or private. The "value" of your 401k is the total cash out amount. Meaning if you sold everything at that moment, what would it be worth. In actuality, you own paper, which shows that you are a partial, albeit small, owner of said companies.

    I would suggest meeting with a financial planner to see how you want to allocate your funds.
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    Member Array hidden's Avatar
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    Quote Originally Posted by taseal View Post
    Can someone like 'dumb' this down for me?

    I thought it was just like a savings account that your company that you work for pitches in as well...

    I put in 5% into it, and my company gives 125% of what I give. pretty good I guess... however, as i'm looking at my account I see that it's almost like a stock. it kind of goes up and down etc...

    how does it work? the wiki article had me confused
    Several benefits to a 401K...

    1. The funds you contribute are withheld on a pre-tax basis, so they reduce your taxable income for the year they are withheld. So if you made 100K, and contributed 10K to your 401k...your taxable income is only 90K. In this example, you would save something on the order of $3200 on your annual income tax due to the 10,000 reduction in taxable income.

    2. Your company match is free money...consider it a form of a raise or additional income. They match to 125% - this is an automatic 25% return on your investment. That cannot be argued with!

    3. Your funds grow tax deferred - you are not taxed on gains, dividends, etc until you withdraw the money at retirement.

    The best strategy for handling the swings in the market for me, are to just let it ride. Don't watch the value every day...check it quarterly or every 6 months...but don't watch it every day or you will go insane.
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    Senior Member Array Jackle1886's Avatar
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    If I might suggest, look into a Roth IRA. Which is a type of savings account where it starts with money that is taxed, but all the earnings on it are tax free! YES TAX FREE! Look into it.
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    Senior Member Array jeephipwr's Avatar
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    They match 125%? Are they hiring? I need some of that.

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    Senior Member Array jca1's Avatar
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    Quote Originally Posted by Jackle1886 View Post
    If I might suggest, look into a Roth IRA. Which is a type of savings account where it starts with money that is taxed, but all the earnings on it are tax free! YES TAX FREE! Look into it.
    A Roth IRA is an excellent retirement plan, as said all the money your money earns is tax free. You pay tax on what you put it before you put it in but you pay no tax on the profits, unlike the 401K.With the 401K, contributions you make are pre-tax but they will be taxed when you start to draw on it as well as all the money you have made.

    401K's are basically a stock plan, right now is a good time to be starting a 401K cause you're buying stocks while they are down.

    With either of these, remember that long term is the key.
    Since your company matches what you put in and then some, I would suggest you put in as much as you can afford up to their percentage limits, and take full advantage of the free money. The company I work for matches .50 to the dollar up to 6%.

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    VIP Member Array ccw9mm's Avatar
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    Here is an overview: click.

    Here's a book that lays things out fairly simply: 401K For Dummies.

    Here are several 401K questions you might ask: click.

    The goal is to have a tax-deferred investment mechanism that you contribute to over the course of your working life, to which the company might contribute, in which the goal is to have socked away as much as possible by the time you retire. Each company can arrange a 401K plan differently, pretty much along the lines described in the link and below.

    They're not tax "free." They're tax-deferred. They postpone the taxation until a time when you're beginning to withdraw the funds and, presumably, earning far less and are thus in a lower tax bracket.

    Basically, a 401K works this way:

    1. You get a portion of your pay deducted and invested, pre-tax.

    2. The company might match a portion, up to a certain amount. For example, up to $5K invested in a year, the company might chip in 50%.

    3. The 401K might allow you to invest up to a certain percentage of your income, or have no limits. The U.S. government's 401(k) tax code specifies limits as well.

    4. The money is deposited into one or more funds that are managed by an investment group (ie Wells Fargo, Principal Financial Group, whomever).

    5. Of the 50 funds an investment group might offer, the 401K might have 15 of them as choices. Money market and bond funds will tend toward the more conservative end of the scale, while industry-specific, small-company and international funds may tend toward the more risky (volatile) end of the spectrum.

    6. As with any investment, one should strongly consider the principle of diversification as one weapon you have to guard your investment's value. Putting all the eggs in one basket, ie into one company's stock as one of the fund choices, might well end up seeing the total value evaporate if worse comes to worst. Think Enron, here.

    7. The value fluctuates constantly, since the underlying vehicle for the fund will be cash, bonds, stocks and perhaps other investments. Surprise! You can gain or lose amounts every day, just as with any other investment ... sometimes quite a bit.

    8. The investment group generally charges a small fee to manage the funds and cover transfers between funds that you direct, though sometimes the company covers the fees.

    9. The arrangements between the company and the bank establish the amount of vesting you get, ie how much of your/their money is considered yours, and how early it's considered yours.

    10. In some arrangements, you get full control over management of the money and can move it between the various fund options whenever you like. Other arrangements are a bit more limiting in the degree of control you're allowed.

    11. Some 401K plans allow loans (ie, for a house downpayment) you can make to yourself, though that takes the cash out of the fund for the duration of the loan. On the upside, you pay yourself interest.

    12. When you part with the company, you generally roll it over into another fund.

    13. At age 59 1/2, you start withdrawing the funds. The funds are added to your income for that year, and you're taxed as if it were normal income at whatever tax rate applies at that time (instead of at the time of your "peak" earning years when you were socking it away).
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    Restricted Member Array SelfDefense's Avatar
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    I have a but a few things to add to the explanations provided.

    First, there is a basic assumption that when you withdraw the money your tax rate will be lower than today. As taxes are projected to increase, that may not be a good assumption for some people.

    Second, there have been repeated proposals in Congress (since the early '90s) that will simply tax your requirement account, period. Thirty percent (or another large number) could be confiscated. With our nation becoming socialist, I would not be surprised if they took it all. Private property respected? Why? Poor people need your money.

    No matter the drawbacks to section 401(k) a company match is the best return on ivenstment. 125% is awesome. Only one bit of caution. If the company matches in company stock, sell the stock as soon as it vests. It is not a good financial decision to have your paycheck dependent on the success of the same company as your investment. If the company fails or has a downturn you will lose on both fronts.

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    Member Array oldogy's Avatar
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    I would suggest you and anyone with questions enroll in a basic investment, money handling class. Such classes are offered by community colleges, adult education and others. They start out very basic. The sooner you learn to make your money work for you, the better.
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    VIP Member Array ccw9mm's Avatar
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    Quote Originally Posted by oldogy View Post
    I would suggest you and anyone with questions enroll in a basic investment, money handling class.
    Yup. And your company's 401K "plan administrator" person should be able to answer your most basic questions. If this person doesn't have the answer, then he/she can certainly put you in touch with someone at the 401K group who'll be able to. But, ditto on the classes on basic investing. It's important to understand the basic mechanics of how it all works. It's crucial to understand a 401K is merely a tax/deduction mechanism to seed one or more stock/bond funds for you. They absolutely will adjust in value constantly, exactly like stocks/bonds ... because your 401K money has been invested in exactly those things.
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    I wish mine went up and down. For the last several months, I and my employer have been pouring cash into a dwindling puddle. But I have faith that when the economy recovers, all will be well again. I have about 2 decades til retirement....
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    Maybe I misread what he wrote. I read it as the company paying (matching) 12.5% of what the op added to his 401, not 12.5% of his salary. Absolutely, if the company is adding 12.5% of his salary to the fund in exchange for his putting aside 5%, HE IS GETTING A FANTASTIC DEAL. He is getting to save 17.5% of his income, invest it, and avoid taxes (for now) on it.

    But, if the company is matching 12.5 % of his 5%--that is, lets say he earns 100K, saves 5% or 5K and the company matches 12.5% of the 5K or roughly 600 + bucks per year, that may not be such a good deal at all. Better than no match, but nothing to brag about.

    The other thing he needs to look out for is where the money is being stashed, and who controls that and what they are charging his account for the privilege of "taking care" of his money. There are plenty of "managers" who will eat up the match in fees and charges, and other expenses.

    The OP also needs to learn something about the basics of investing. I know one unfortunate person (not myself) who was convinced by a "financial adviser"
    hired by his company's plan to sell all his stock at the bottom and buy bonds.

    Duh, the poor guy locked in his stock losses, incurred transaction/broker fees on the sales, can't deduct any of it at tax time, and now holds interest bearing
    bonds and CDs that pay almost nothing in real terms. The winner was, you betcha, the financial adviser who got the commission on the churn.
    Last edited by Hopyard; August 5th, 2009 at 06:11 PM. Reason: changed the word "stock to bonds" to correct error

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