Planning for your retirement doesn't have to be a daunting task, provided you are well-informed about your choices. In this article, we will delve into the specifics of 401K and 403B retirement plans. These two plans are fundamentally similar, with the primary difference being that 401Ks are utilized by for-profit organizations, while 403Bs are used by non-profit entities, including government organizations.
A 401K plan allows an employee to contribute a portion of their pre-tax salary. This means that the account grows tax-free until you retire or leave the company. Consequently, 401K contributions are not included in your taxable income. In essence, you receive an immediate tax deduction for your contribution.
Many employers offer an automatic payroll deduction, eliminating any extra effort on your part. Additionally, employers often provide matching contributions or partial matching contributions as an incentive. For example, an employer might match every dollar you contribute with a quarter. While this may seem insignificant, the power of compound interest can significantly boost your savings over time.
There are, of course, rules and regulations to consider. Typically, you are limited to a percentage of your income or $10,500 annually, whichever is less. If you leave your company, you have three options: leave the account as it is, roll it over into another tax-deferred retirement account such as an IRA, or withdraw the entire amount. However, early withdrawal penalties, applicable before age 59-1/2, are substantial. Usually, it's a 10% penalty plus any taxes owed. Therefore, it's advisable to avoid withdrawing any funds before age 59-1/2 if possible.
Your 401K portfolio should be chosen carefully, taking into account your age and risk tolerance. The older you are, the less stock you should have in your portfolio. Many financial advisors suggest that the percentage of stocks in your portfolio should be 100 minus your age. Therefore, a 25-year-old's portfolio should consist of 75% stocks. However, if you're not comfortable with that level of risk, you can opt for fewer stocks. It's worth noting that over the last century, the stock market has returned an average of 11% (including during all wars and the Great Depression). Your plan will likely offer 4 to 7 investment options of mutual funds, stocks, bonds, etc. for your portfolio.
Choose wisely and consider how much risk you are willing to take. Most importantly, you need to be comfortable with your choices. If you need further assistance in choosing your investment options, consider checking out Morningstar or the MorningStar books at your local library.
