5 Little-Known Perks of 401(k)s

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  • 401(k) contributions are tax-deferred.
  • Investing in a 401(k) offers you a measure of control.
  • It's easy to invest in a 401(k) that caters to your risk tolerance.

Now is the best time to prepare for retirement.

For those of us not born into wealth, planning for retirement is a steady, deliberate process. One great tool is a 401(k). Whether it's employer-sponsored or a Solo 401(k), this financial tool offers five sometimes-forgotten benefits.

1. Tax advantages

Funds contributed to a traditional 401(k) are taken directly from your paycheck before taxes are withheld. Let's say that your gross pay each week (that's the amount before taxes) is $3,000, and you're contributing 10% to your 401(k). That means that instead of being taxed on $3,000 per week, you'll only be taxed on $2,700 ($3,000 minus $300).

Depending on how much you earn, it could even knock you into a lower tax bracket. As long as you leave the money alone to grow until retirement, you won't have to pay taxes on it until you begin to make withdrawals. And chances are, you'll be in a lower tax bracket after retirement.

2. The power of time

As you probably know, the earlier you begin investing, the more time compound interest has to help it grow. The beauty of compound interest is that it allows you to earn interest on both your principal balance and any accumulated interest.

However, even if you got a late start, you can let your investment ride. Yes, you'll have to withdraw an annual required minimum distribution (RMD) once you reach age 72, but there's no rule saying you can't reinvest it (if you can afford to) and allow the remainder of your money to grow.

3. Two types of control

There's something about putting money away in a 401(k) that makes it easier to keep your hands off it. Maybe it's the fact that you're charged a penalty if you take it out before you're eligible, or perhaps it's a desire to avoid the paperwork associated with an early withdrawal. Whatever the reason, the best thing you can do with your retirement investments is to leave them alone and let them grow. A 401(k) makes that easy.

With a 401(k), you determine how much you're going to contribute. You decide your level of risk tolerance. And you decide whether it's time to increase the amount you contribute (well, you and the IRS, since the IRS puts contribution limits on every plan).

4. It can follow you -- and may be able to change forms

If you change jobs, any money in your 401(k) belongs to you. You can roll it over to another 401(k) or, depending on the type of plan, invest it in another tax-deferred investment.

5. It's easy

It's not only easy to sign up for a 401(k), but most brokerages provide a questionnaire to help you determine your risk tolerance. Knowing your risk tolerance allows you (or a broker) to make investments you'll be comfortable with.

If you haven't signed up for a 401(k) because you're concerned that it will be too complicated, you can release that fear. The process itself is quite straightforward.

If we're fortunate, we'll grow old enough to retire. If we're smart, we'll begin preparing for that day long before it arrives.

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