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The basics of 401k Plans

You must have heard of 401(k) Plans right? Not clear what exactly it is and how well it works? Here’s a brief explanation of the features of the plan along with its functions.

What is the working procedure of a 401(k) Plan?

In a very simple language a 401(k) plan is a retirement plan setup and managed by your employer. You get to choose from a selection of investment funds based on risk that you would like to invest in. It is at your discretion to choose the specific investment fund you would like to invest in. You then indicate what percentage of your paycheck you would like to contribute to your plan each paycheck.

Once this amount has been decided by you, it will directly get deducted from your paycheck but without being taxed for it at that moment. There is a specific limit up to which you can contribute to your account. Some employers offer a matching program where they will match dollar for dollar of 50 cents on the dollar for each amount you set aside up to a certain limit - say, 3-6%. This is free money you should take advantage of.

When do you go for a 401(k) Plan?

It is never too late to start investing in your company’s 401k plan. The sooner the better. The sooner you start, the more you will have available to draw from when you retire.

What to invest in your 401k?

This is always a tricky issue because you are ultimately responsible for what you invest in and if a company or financial adviser or friend gives you advice and the returns are not to your liking, they do not want to be liable in this sue-happy society.

The general idea is that you should invest in the riskier investments the longer you have until you retire. More risk = more reward over the long term and since you would have several years to weather the ups and downs of the market you could go for the riskier options. If you have a few years until you retire, you would want to stick with more conservative funds to preserve your investments.

Consult your financial adviser for specific advice. You can also check out sites like Fool.com for more advice.