The 401(k) plan is something that many people hear about, but a huge part of the workforce doesn’t fully understand how they work. I’m going to outline some of the basics to a 401(k) plan and also my opinions as to how much you should put in, when to start it up, etc.

For starters, the term 401(k) just comes from the section of the Internal Revenue Code that this plan comes from. Section 401(k). Not really that big of a deal, and apparently the government couldn’t come up with anything more exciting - at least it’s easy to remember where to look in case you need to dig up some facts. A 401(k) is an employee-sponsored retirement plan. You have to be employed in order to start a 401(k) - some people may notice that they can’t open a 401(k) even though they are employed; if you work for a non-profit organization, a 403(b) is very similar and is becoming increasingly identical to the 401(k). 401(k)’s invest in a number of assets - stocks, mutual funds, etc. It depends on the employer as to how this mix will be made up, but typically it is something very safe in the long run and something that grows very well. There are contribution limits of $15,500 per year per person. Quite a bit of money, as a lot of Americans don’t have enough income to fully fund their 401(k) each year; this limit will be increasing in the future years, just as a heads up.

Starting up a 401(k) offers a number of benefits besides just having a retirement account set up. Many employers offer matching, some up to 100%. Matching is a simple concept - at my job, when I put $1 into my 401(k), my employer will also put $1 into it (up to 4% of my income). Some don’t offer 100% matching, and some offer none. Those that do most often have what’s called a vesting period. Vesting refers to how long one has to be at the employer for the matching to be kept. My current employer starts this the first day you start your 401(k), but others can go up to three years - the legal limit is three years and then you are vested. Some will offer different increments - at six months they’ll give you 25% of what they put into your account, for example. If you’re unfamiliar with these, check with your employer to see what matching and vesting procedures they are using. If they match you, you’re getting a 100% return on investment; pretty good, if you ask me.

401(k)’s also operate tax-deferred, which can be a huge bonus. Tax-deferred means that it’s taken right out of your paycheck, before the taxes are - they are deposited into your account, where they grow. And grow…until you’re legally able to withdraw money without a penalty (typically 59 1/2, with a few exceptions that I won’t go into). You are taxed on the money when you take it out, but it’s been growing tax-free for years which will help balance out any taxation. This saves you money two different ways: 1 - You are not paying income taxes on that portion of money you put into your 401(k). 2 - You are automatically saving, and helping fund your retirement.

What if you’re self-employed, though? Sorry to say, but the 401(k) doesn’t apply to you - instead, the SEP, or Self-Employed Pension - does. SEP’s operate similar to 401(k)’s, but offer lower administrative fees and different contribution limits. I’m not very familiar with these plans, but presently the contribution is something along the lines of 25% of ones income, or $44,000; whichever is less. I won’t go into much more detail than that, but if you’re self-employed, do some research if you’re interested.

How worthwhile are these retirement plans, anyhow? For that, I resort to my good ol’ DinkyTown 401(k) Calculator. Click on the picture below to be taken to the full version - essentially you will see that if I put in $4000 a year, get decent employer matching and don’t touch it till I”m 65, I’ll have slightly over $2,000,000 in my 401(k).

Just as a quick recap, I’ll outline the basics:

• 401(k)’s and 403(b)’s are retirement accounts set up by an employer.
• Many employers match a certain percentage or dollar amount that you put in.
• Money in a 401(k) or 403(b) grows tax-deferred - it is taxed when you withdraw money.
• Money put into a 401(k) or 403(b) will lower your net income, saving you tax money now.
• If you’re self-employed, look in to a SEP IRA account.

401(k)’s are great ways to invest money for your future. If you are relatively young - in you’re 20’s - and have a 401(k) started up, you’re off to a fantastic start. Even if you’re older, 401(k)’s can help you out even if you’re just starting out.

Well I wasn’t even planning on writing an article like this, but sitting here tonight just browsing TV stations and doing a bit of light reading, I suddenly became inspired. I just kept the channel on from the program I was watching, and now it’s an infomercial for “Winning in the Cash Flow Business”. They claim that you can “retire earlier than you EVER dreamed possible!” While I hope that this goes without saying, I still feel the need to comment on this - and other “business opportunities” - and how if it sounds too good to be true, it’s likely that it is too good to be true.

I did a bit of further digging on “Winning in the Cash Flow Business”; and when I say further digging, I mean I went to Google and typed in the title, then hit on the I’m Feeling Lucky button. I was taken to InfomercialScams.com where I read many comments about people dropping hundreds, even THOUSANDS of dollars on this. After reading the first handful of comments, I was too disgusted to read on.

Because this topic is painfully obvious to me, I am cutting it short. Before you invest in ANYTHING, do your research. If an offer sounds very good and probably too good to be true, then it probably is. Researching things before you spend money will save you hundreds or thousands, and many headaches as well. Lastly, don’t be too anxious to earn money that you become short-sighted of these factors. And if you’re going to drop any money on “Winning in the Cash Flow Business”, send me money instead and I’ll find a use for it. =)

Over the years, I’ve noticed that many people do not save for retirement until they are well into their working lives. Often times, people don’t even start saving until they’re in their mid- to late-twenties. Having a father who is a Certified Public Accountant, I was made aware of the benefits of saving while I was young.

While you are young, though you earn less money, it’s taxed much less. Last year, for example, I got basically all of my Federal taxes back. Since I’m taxed at such a low bracket, the money I made last year (and the year ending this April 15) is good to invest in a tax-exempt account, like a Roth IRA. These accounts are nice, because the money in them can grow tax-free. I don’t have to worry about paying taxes when I take my money out, and I don’t need to worry about paying a penalty so long as I don’t take out more money than I put in the previous year. This makes it a great savings tool for the long run - retirement - and also good for other things like a down payment on a house, though personally I will invest my money differently.

Once you have any earned income, you can put money into your Roth IRA; as much earned income as you have. By putting money into my Roth IRA for the past few years, I essentially have a huge amount of money waiting for me when I am 60 even if I don’t add any more money for 40 years.

Another benefit of saving money early is to help keep yourself out of debt. While I strongly encourage everybody to live well within their means, sometimes there are unexpected emergencies that can cause hundreds or thousands of dollars - car problems, health issues, etc…by saving money early, I’ll be more prepared to handle tough financial situations in the future.

On average, Americans typically spend more money than we make. Certainly this is obviously not true for everyone, hopefully everybody who reads this, but it’s still a scary statistic. Putting away 2%-5% of your gross income can greatly help you accomplish future goals, and will give you peace of mind by knowing that you’re financially secure.

In the meantime, I’ve found that the Roth IRA calculator at DinkyTown.net is a good tool to see roughly how much you may have in your Roth at retirement. If I don’t add anything else in, I will have about $188K assuming a 9% return rate. Not bad, for not throwing any more money in there; so just think about how much that’ll grow when I do add money each year!