Smart 401k Plan Maintenance: Why You Should Contribute as Much as You Can

Up until the past few decades, everyone either expected to retire on Social Security, or if they were lucky, they had a company pension. Although some companies still offer the standard retirement plan, more and more companies are eliminating the standard retirement plan and replacing it with a 401K Plan. Even some companies who previously had utilized what was previously known as Profit Sharing Plan have diverted those funds into a 401K Plan.

For those who may be unfamiliar with a 401K Plan, how it works is that an employee is permitted to contribute a certain percentage of his or her pay (usually up to 6%) and the company contributes another percentage. For some companies they match 100% to what the employee contributes; in other words, if the employee contributes 6%, the company matches that percent. Other companies may choose to match the employee 50% or 25%.

The big advantage to a 401K Plan is that the first 6% that an employee contributes is considered "before tax dollars," meaning that the first 6% you contribute to your 401K Plan reduces the amount of taxable income by the amount of your contribution. In other words, if you earn $600 per week and contribute 6% of that to a 401K Plan, instead of having a taxable income of $600, your taxable income is only $564. At the end of the year when you receive your W2, there will be two different figures on there for income: one is gross income, and the other is taxable gross income, which is the amount AFTER your contributions to your 401K Plan.

Another advantage of a 401K Plan is that under certain "emergency provisions," you are permitted to withdraw funds without a penalty. These emergency situations are defined under the Federal Government but include things such as purchasing a home, eviction, foreclosure, college, and medical expenses just to name a few. Under other circumstances, you can borrow against your 401K, and the interest that is charged goes back into your fund, so in essence, you are borrowing from yourself at a lower rate of interest, and the interest you pay on the low is paid to you instead of a bank.

The final advantage that will be discussed in this article relates to the movability of a 401K Plan when you leave the company. In the past, if you had a standard retirement plan, if you left a company before retirement age, whatever money had been set aside in a pension fund was lost.

With a 401K Plan, whether you are laid off, fired, or leave a company of your own volition, you have the option to take the 401K Plan with you to another company. What this means is instead of simply withdrawing the funds from your 401K Plan and paying a penalty for early withdrawal, you can ask your former employer to "roll over" the funds into the 401K Plan offered by your new employer.

In the event that your new employer does not offer a 401K Plan, you can either leave the funds with your former employer until you retire or you can do a "roll over" into an IRA or Keogh Plan to avoid paying an early withdrawal penalty. This would also allow you to claim the credit on your income taxes for deposits into an IRA account.