Tax Benefits of a 401K Plan
One of the most important things to know about a 401K plan is that the money you put in your 401K is before taxes. Contributions taken from your paycheck, before taxes are deducted, will lower the income you have to pay taxes on.
Alright, let's think about how this affects you overall, would you rather fund your future and pay less tax or keep more money in your pocket now and pay more tax. It's an easy choice to make now, right>
The fund your future there is one catch to 401K plans. If you make withdraws before the age of 59 and a half you have to pay a 10% early withdrawal penalty on top of any taxes due. Word of advice, don't touch that money unless it's an emergency.
For example: Suppose a single taxpayer earning $55,000 per year has a 401K plan and starts contributing $5,000 a year. That means he is in the 25% federal tax bracket. Since the 401K is fully deducted, his taxable income for the year is now only $50,000, saving the taxpayer $1,250 per year.
Another great benefits of a 401K plan is the employer matching feature. Employer matching is when your employer contributes around three to six percent to your retirement savings plan, based on your annual contributions. Occasionally, employers may decide to match employee contributions up to a certain dollar amount regardless of the employee compensation. However, there are limits and it varies from employer to employer.
A big note to take away from a 401K plan is that when you are in need of some cash, you can actually borrow from your savings plan. In other words, you can borrow from yourself and pay he money back and bring the 401K plan back to its original state. Yes, it is a tax-free event but you must repay under the rules designed.
Here are some reasons why you should borrow from your 401K plan and not the bank or other lenders:
It is quick and convenient and does not affect your credit rating or generate any inquiry against your credit.
Repayment flexibility, because you are borrowing from your own funds
It is economical because there is no cost to borrow (other than administration fees and loan origination fees and what not)
Disadvantages of taking a loan out of a 401K plan:
The outstanding money is not invested; therefore, you lose the opportunity for investment gains
If you lose your job for any reason from the current employer, you must pay back the 401K loan within 60 says or you will be subject to taxes and early withdrawal penalties.
Our goal is to help you be financially prepared for returement. Hope this blog was an interesting read and gave you some insights on 401K plans.
"Opportunities don't happen. You create them." ~Chris Grosser