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Finance For Dummies

Finance For Dummies offers personal finance information on investing, retirement investing, finance, insurance, credit cards, loans and more. Personal finance education is our goal.

Sunday, April 23, 2006

I have a 401k at work--now what do I do?

Many, if not most, white-collar jobs these days offer a 401k. A 401k is an investment vehicle for retirement offered through employers. It is taking directly from your paycheck and is pre-tax investing. If you are a novice investor this can be pretty intimidating, but here are some things to think about while deciding.

Does your employer match your contribution?
  • Some do and some don't.
  • Some are generous and some are not so generous.
  • If your employer matches up to a certain percentage that you contribute to your 401k then it is often best to invest as much as possible up to the matching point.
  • So if your employer matches up to 5% of your contributions and you can afford to contribute 5% of your income then you should because it is FREE MONEY!
  • Keep in mind many companies do not allow you to leave your job and immediately take the 5% your employer matched with you. Often there can be a timetable for the amount of years tenure at your job that allows you to keep a certain percentage of the employer match.
  • Let's say 1 year=25%; 2 years=50%; 3 years=75% and 4 years employed you are 100% vested. You make $50,000 a year you contribute 5% of your pre-tax income to your company's 401k--that is $2,500 a year. Your employer matches that 5% so after 1 year you have $5,000 in your 401k (not counting market losses or gains). You now decide to leave that job after 1 year of service. By following the vesting timetable above you would keep 1/4 or $625 of your employer's match. Therefore, you have $2,500 that you contributed plus the 25% vested interest of the $2,500 match equalling $3,125. So you made $625 for free because of the vesting timetable.
  • Your employer does not match any contributions you make. In this scenario it is often best to not contribute to the 401k and instead pay back credit card debt (if you have any) or contribute after-tax money to a Roth IRA. You should do the Roth IRA because you will have many more options to invest in with a Roth of your own than investing in your company's 401k which will have a limited amount of choices to invest.

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