Investors get confused sometimes. The telecommunications company Inter-Tel
With that in mind, I hereby offer a little guide to 401(k)s, lest anyone plunk their critical retirement funds in the wrong place.
In a nutshell
A 401(k) is a retirement plan that allows you to put part of your paycheck into a special kind of account. The funds are contributed on a pre-tax basis (meaning the money is deposited in your account before Uncle Sam can take out income taxes), serving to reduce your income and therefore your taxes. Meanwhile, your contributions and all earnings remain untaxed until withdrawn from the plan. The 401(k) may also permit voluntary, after-tax contributions. Earnings on after-tax contributions accumulate tax-free until withdrawn.
One of the best parts of 401(k)s is that employers often offer matching funds. For example, your company may match every dollar you contribute, up to 5% of your salary. If so, and if you earn $50,000, that means that when you contribute $2,500 to your 401(k), your employer will kick in another $2,500. That's free money. That's a guaranteed 100% return! Be smart -- take maximum advantage of any matching.
The wrong 401 plans
As I've done before, warning people about investing via the wrong IRAs, I present below some wrong 401 plans. Steer clear!
401, the area code: You may find your telephone company offering a 401 plan -- if so, it's probably a plan offering special rates for making calls to Rhode Island. Go ahead and sign up if your grandma lives in Providence, but don't contribute $4,000 per year to this plan and expect it to pay for all-you-can-eat buffets in retirement.
401, the highway: Don't drop much of your retirement money into this 401, either. It's a highway in Canada, and the tolls, if there are any, are likely to be much less than several thousand smackers per year. The highway may indeed help you get from point A to point B, but those points may be Toronto and Ottawa, not life in a cubicle earning $50,000 per year and life in retirement on $40,000 per year.
I-401, the submarine: This would be a particularly unfortunate 401 to plunk your hard-earned money in, because it was a Japanese World War II submarine, and it sank during target practice in 1946. If you're looking to lose money, perhaps consider some poor-performing stocks. Rick Munarriz recently listed some stinkers of 2005 that may well keep stinking into 2006 -- they would have taken most of your 2005 funds, but at least they would have left you with a little to lose in 2006. The stocks Munarriz discussed included Travelzoo
The right 401 plans
So now you've got it, I think. Focus on the 401(k) -- or its sister plan for non-profit employees, the 403(b). There's a lot to like about 401(k)s. Learn much more in our 401(k) nook.
Finally, make sure you're tending to your big retirement picture. Begin planning now. We can help you reach your dreams with our Rule Your Retirement newsletter. It's issued each month, is readable in a single sitting, and contains lots of valuable tips, as well as inspiration and motivation. (You've got little to lose and a lot to gain by trying it for free.)
These articles may also be of interest:
- 60-Second Guide to Maximizing Your 401(k)
- Don't Max Out Your 401(k)
- 10 Ways to Mismanage Your 401(k)
- Job Changes and Your 401(k)
- 401(k) Tips
- Do You Want to Work Forever?
- Get Rich by Beating the Odds
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Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.