What is a 401(k) Plan & What Other Retirement Plan Options Are Available?

There are a number of retirement plan options to help you save for your retirement. First, there is the 401(k) plan. Frequently offered by employers today, these plans "may be one of the best retirement savings vehicles available to you, particularly if the employer matches all or a portion of your contribution" (MetLife Consumer Education Center, 2008, Retirement Plan Options section). 401(k) plans allow employees to contribute up to a specified percentage of their gross income every year to be invested in any of the specific plans investment options. All earnings continue to be tax-deferred until you withdraw from the account. If you make early withdrawals (typically before you turn 59 ½) for a reason that is not considered "qualified" by the IRS, you will have to pay income tax, as well as a tax penalty, on the amount withdrawn. Finally, some 401(k) plans allow you to borrow money from your account balance, as long as it is repaid in a set period of time with interest (MetLife Consumer Education Center, 2008).

Other Retirement Plan Options

403(b) plans are actually quite similar to 401(k) plans, but are available only to those who work for public and private schools or colleges/universities or for a non-profit, tax-exempt organization. IRAs, on the other hand, allow you to set aside up to $5,000 each year and still receive tax advantages (which vary depending upon which type of IRA you choose, how much you make a year, and if you have any other investments that offer tax advantages). If an individual is 50 or older, he or she has the option to save an additional $1,000 each year if he or she missed years or contributed less than the maximum amount in previous years. The two types of IRAs are (1) the traditional IRA and (2) the Roth IRA. Finally, Keogh plans are available to those who are self-employed (MetLife Consumer Education Center, 2008). "Generally, a maximum of 25 percent of net income, up to a maximum amount per year, can be contributed on a tax-deferred basis" (MetLife Consumer Education Center, 2008, Retirement Plan Options section).

Added Bonus: Compound Interest

Some retirement plans offer an added bonus: compounding interest. Compounding interest can take a small amount of money and turn it into an amazing amount of money over a long period of time. Basically, when an account has compounding interest, all interest it earns is added to balance. Once this interest is added, it will earn interest (along with your original investment). And in turn, this amount of interest will be added. This increased balance will eventually earn interest as well and this cycle will continue as long as the money remains in the account. As such, the longer your investment stays in such an account, the larger your balance will be become, as interest is earned on interest and more interest is earned on that interest (Money Instructor, 2005).

References:

MetLife Consumer Education Center. (2008). Investing for the first time. Retrieved June 16, 2008, from http://www.metlife2000.org/Applications/Corporate/WPS/CDA/PageGenerator/0,4773,P2005,00.html

Money Instructor. (2005). The power of compounding. Retrieved June 19, 2008, from http://www.moneyinstructor.com/art/compounding.asp