What is a 401K?

If you want to retire at a reasonable age and live a comfortable retirement, you will want to learn a little something about 401K plans. If you have a pension, that is great, but a hefty 401K can be a nice addition to your retirement income in your retirement years.

A 401K is a type of retirement account. You are able to contribute money to this account and you won't have to pay taxes until you withdraw the money. Money compounding tax free is a huge advantage. That is why you should take advantage of a 401K with your employer.

Another big advantage is the potential for an employer match. Often as an incentive for you to contribute to your retirement account, employers will offer to partially or completely match what you contribute up to a certain amount.

For example, if you contribute 5% they will match what you contribute by 50%. If you contribute 10%, they will match it 100%. Of course, this is only an example and will vary from employer to employer.

One of the downfalls to a 401K over other mutual funds and investment accounts is that you are stuck with whatever fund your employer's chosen provider invests in. There is very little leeway in what you can do with your invested money. Ultimately, the tax-free advantage and employer-match far outweight this downfall and you should still take advantage of the opportunity.

There are some 401K rules and requirements before you can set up and contribute money to your own 401K. It is a tax advantage service and it wouldn't be fair if just anyone could use it with no limitations whatsoever.

401K Rules

The first of the 401K rules is the simplest to abide by because it is that your employer must offer a 401K to its employees.  Of course you can't sign up for something that is not available to you.

Second, there are contribution limits.  You can contribute any percentage of your income as long as the total annual contribution doesn't exceed $16,500 in 2009 without the employer match and $49,000 with the employer match.  These numbers change almost every year to be adjusted for inflation.

Third, you can't make more than a certain amount of money.  In other words, highly compensated people are not able to enroll in a 401K plan.  One of the 401K rules is that this tax-advantage program is meant for low-paid employees.  A highly-compensated employee is someone who makes more than $100,000 per year.

The 401K rules are constantly changing and it is hard to keep up with them all.  For example, the limits are changed annually to adjust for inflation and new rules are enacted frequently.  You must speak with your employer and 401K provider to get the most updated 401K rules for your plan.