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Tag: 401k

  • Benefits and Downsides of 401k

    Eliud Masika, MBA

    Like anything else, every investment has benefits and downsides. Saving for retirement
    is no exception.
    Here are some of the benefits of 401k:

    1. Tax advantage especially the traditional 401k/403b. For instance, if you earn
      $100,000 and contribute $20,000 to traditional 401k, then you will pay taxes on
      $80,000 of the income.
    2. Employer free money through matching. That is, if you contribute 5% of your
      annual income of $100,000 which is equivalent to $5,000, then the employer also
      contributes to your account $5,000 and essentially you will have $10,000 in total.
    3. Your money has the potential to grow on average 7% every year. Overtime, you
      may accumulate wealth investing in 401k.
    4. Generally, 401k is protected by federal law from most creditors and bankruptcy
      protection. This makes 401k arguably a safer investment.
      These are some of the common downsides of 401k:
      1.Taxes on withdrawal. Unless you have a Roth plan, you pay taxes when you withdraw
      funds from your account now or even after you retire.
    5. Access to your 401k whether traditional or Roth is limited until your retirement age.
      IRS guideline is 59.5 years. In simple words, your 401k is intended only to be accessed
      when you retire.
    6. Penalty on early withdrawal. If you withdraw funds from your retirement account
      before the age of 59.5, then be ready to pay a 10% IRS penalty. Exceptions exist per
      IRS guidelines, especially emergencies, medical expenses not covered by insurance
      and first-time home buyer.
    7. Fees charged by administrators of the plan. Almost all custodians charge a small fee
      for custody of your funds. Although small, these adds up because a typical person
      invests 20 to 30 years. This can significantly lower your investment. Always read your
      quarterly statements and review expense ratios.
      Savage Opinion: 401K benefits outweigh the downsides especially if your employer
      offers matching. This is true with employers that match at least 5%. Anything less than
      5% matches from your employer, reserve the right to talk to a financial advisor.

  • Taxes and 401k

    Eliud Masika, MBA

    Taxes affect your 401k or 403b significantly. Whether you have Roth or traditional 401k, taxes still affect your investment but differently.

    Taxes affect Roth when you get paid. In other words, every time you get a check from your employer weekly, bi-weekly or monthly, taxes are taken right away before your money is invested. This action of taxes being taken away before the funds are invested ensures that by the time you retire, you will not pay any taxes as you have already paid. At retirement, you just withdraw money and no worries about taxes.

    Taxes also affect the traditional 401K/403b. Taxes are not taken out of your paychecks. This reduces your taxes now and therefore your taxable income is reduced. Your investment grows tax free. However, at retirement, you will pay taxes.

    Whether Roth or traditional 401k works for you, it depends on your financial planning. Roth is better for you if you expect your income to be higher at the retirement age. This is because higher income means higher tax bracket, and Roth is ideal for this because you will not pay taxes. For example, high skilled jobs like doctors, Roth is a better option.

    Traditional 401k is ideal for those that expect to be in a lower tax bracket as they are going to pay taxes which is ideal for low skilled jobs.

    Some people, mix Roth and traditional 401k at 50 percent each. This is brilliant because they reap reduced tax benefit from traditional and at the same time benefit from no taxes on the other 50 percent Roth.

  • 401K Roth vs 401K

    Eliud Masika, MBA

    For those who have invested in 401K, you have seen Roth 401k and wondered what the difference between Roth and regular traditional 401k is.

    The main difference lies on how they are taxed . 401K Roth is a post-tax and traditional 401k is pre-tax. Both offer different benefits depending on your financial situation. To decide which best suits you, a tax professional must evaluate your financial situation.

    Generally, traditional 401k suits individuals that expect to earn less at their retirement age and therefore fall in lower tax bracket. In this case, 401k pre-tax may serve you well. Plus, it lowers your taxes every year before retirement age.

    On the other hand, 401k post -tax, you pay taxes now and you do not receive the benefits of lower taxes, however at retirement you do not pay any tax when you withdraw your 401k funds. This suits those who expect their tax bracket to be higher at retirement.

    So basically, Roth 401k and 401k differ only on when tax is paid on withdrawals. To maximize tax benefits in your particular situation, consult your 401k plan administrator or financial advisor. Vast number of people invest in traditional 401k because it gives immediate tax relieve and most people are likely to make less income at retirement and do not have to worry on higher tax bracket.

  • How 401K Saves Money

    Eliud Masika, MBA

    401K has been around for decades, and yet only few employees contribute to 401k, or 403b (non-profit organizations).

    The reason for only few employees contributes to 401k is because of lack of information. Actually, most HR vaguely talk about 401k to their employees and this result in fewer employees enrolled to this important investment vehicle.

    401K does save money than when you would have not contributed. This is how 401k saves you money and instead invest it for you:

    1. Regular/Traditional 401k (pre-tax)- reduces your taxable income. This means your contributions from your paycheck is not taxed, and as a result, you pay less taxes. This automatically saves you money that would have been taxed by the government and instead invested into your 401k.
    2. Most employers offer a match. This means your employer also contribute to your 401k. Usually, employers offer a match of 3% or 5%. For example, if you contribute 3% of your paycheck to 401k, the employer also contributes 3%. This is called matching. Essentially, this is free money to you from your employer. Note: The employee must contribute to receive the match. Your HR department would have a booklet for your company’s specific match whether it is 3% or 5%.
    3. Some companies allow employees to borrow money from their own 401k and interest they pay on the loan goes back to their 401k. This is by far better than borrowing from a bank. No credit score check required. Most plans may allow up to 50 percent of invested for borrowing.
      Note: Borrow from your 401k if it is absolutely necessary. Borrowing from your 401k may limit the compounding power of your investment plus if you leave your job, the entire loan may be due immediately or within 6 months per IRS guideline.
    4. The most important aspect of 401k is compound growth. The money invested can grow over time. Most 401k investments have a 7% annual return. As 401k’s are designed for retirement, this can be signaficant especially if you start investing early and make regular contributions.

    401K’s are good vehicles to start investment for employees. They are simple to start via your employer, and most companies have professionals that handle their plans. If you would like to invest in 401k, your HR department is very valuable in providing information and specifics of your 401k plan.