401(k) retirement plans are popular investment vehicles for
people that are employed. Employees can utilize employer
sponsored 401(k) plans in order to invest regular amounts of
their income into mutual funds, stocks, or bonds.
401(k) plans are straightforward investment structures for
people who want to put money toward their retirement while they
desire little involvement with investment decisions at the same
Essentials of a 401(k)
In a nutshell, 401(k) retirement plans offer employees the
opportunity to invest a part of their monthly income in a mutual
fund or stock (including company stock) and benefit from a
payroll tax deduction in return.
Retirement savings contributions are not taxed at the time of
contribution, which is a major benefit of a 401(k), but they will
be taxed later on when funds are distributed.
401(k) plans are classified as defined-contribution plans
meaning employees absorb the risk of their investments and their
employer does not make a guarantee with respect to future pension
Many employers, however, offer a 'matching contribution' which
means that they will match any employee contributions, though
this will likely be capped at some percentage of the employee's
Employees can usually withdraw their funds when employment
ends and they enter retirement, when they reach the age of 59.5
years or the plan is terminated. Many 401(k) plans also include
hardship conditions under which participants may access their
in times of extraordinary need
If you like to read up on 401(k) plans, consider the
from the Internal Revenue Service which has a bunch of helpful
information and clarifies any further questions you might
Put simply: You are not required to pay taxes on your
contributions now and you might get your employer to chip in via
matching contributions. Sounds like a sweet deal.
Further advantages of utilizing the 401(k) route for
retirement saving are presented below and employees are advised
to take full advantage of this investment vehicle to build up
their nest egg:
1. Compounding leads to higher capital returns
The biggest advantage a 401(k) offers is the feature of
This has profound implications for investors as their
investment returns are
taxed during the life of the 401(k): Not having to pay taxes on
investment returns translates into a higher asset base that
continues to earn more money for the future retiree over time.
This compounding effect works to the benefit of the investor and
can lead to a portfolio that can accumulate quite substantially
over long periods of time.
Employees should proactively talk to their employers and seek
out their 401(k) offers. The maximum amount of compensation in
2014 that employees can defer
stands at $17,500
2. Structured approach to retirement planning
401(k) plans are a great concept to lend structure to your
retirement planning. First of all, contributions to your plan
will be made automatically and on a regular basis.
Secondly, employees and investors might find it a daunting
task to decide what stocks or asset classes to invest in and at
what times. Utilizing a 401(k) puts retirement planning on
autopilot as investment decisions will no longer be a cause of
worry for you.
3. Smoothing out volatility
Another convincing reason to invest in a 401(k) relates to
smoothing out market volatility.
At any particular time, the stock market could tank and with
it the value of your 401(k). If you make regular contributions
via such a plan you will continue to make investments in stocks
and mutual funds when their values are consolidating in a
recession and are therefore cheap.
If you participate in your 401(k) retirement plan over many
years, the inherent fluctuations of the stock market as well as
the fluctuations in economic activity will balance out and work
to your benefit.
The Foolish Bottom Line
401(k) retirement plans are great investment vehicles for
employees who desire a structured, low-maintenance approach to
Understand that the major benefit of a 401(k) lies in offering
you the benefit of compounding, which allows you to earn
substantially higher returns over long periods of time
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Retirement Planning: 3 Strong Reasons Why You
Should Invest in Your 401(k) Plan
originally appeared on Fool.com.
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