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masikafinance

Tag: retirement

  • 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.

  • 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.