The Basics of a 401K

If you have ever taken any sort of investment class you have heard about the power of compounding. Compounding allows a small amount of money, invested over a long period of time, to become a much larger amount of money, building wealth for the person wise enough to invest their money long-term. 

A 401(k) retirement plan is a special type of pension plan that, like many long-term investments, can pay-off handsomely down the road.  The funds that a person places in their 401(k) account can be used to invest in stocks, bonds and mutual funds as well as many other types of assets and, since they are funded by pre-tax payroll deductions, are not taxed until they are withdrawn. This allows them to take advantage of the fact that they aren’t dwindled by capital gains and dividends taxes as well as interest taxes and will make the investor much more money over the lifetime of the 401(k)

Indeed there are 5 benefits that make investing in a 401(K) a principally attractive option for investors.

  1. The tax advantage as mentioned above, means that the money invested in the 401(k) won’t be taxed until far in the future when it’s finally withdrawn to fund someone’s retirement. There are no taxes on capital gains, dividends or interest until that day, allowing the money invested to take full advantage of compounding interest.
  2. In order to attract and retain talented employees many companies offer employer match programs for 401(k)s, matching funds up to a certain percentage of what is deposited every year. This can add a substantial amount to the 401(k) over the long-term.
  3. 401(k) programs offer customization and flexibility that many other types of investment just can’t match.  This gives the person who owns the 401(k) a lot of opportunities to invest that otherwise would be closed to them.
  4. The fact that a 401(k) is portable, meaning that it can be taken from job to job as you move up or around in your industry, is very attractive.  Unlike a pension that stops if you stop working for a particular company a 401(k) can be take with you wherever you go.
  5. Being able to withdraw money for hardships and other loans is also a feature that makes 401(k) plans a favorite as other plans can sometimes force you to pay significant early withdrawal fees for taking your money out before they mature.

All told, 401(k) retirement plans are one of the best, safest and most flexible types of retirement plans that you can invest in, and can be very lucrative due to the power of compound interest.  If you have the opportunity (and the brains) they are definitely an option that you should take advantage of if you’d like to retire in style.

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