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A Simple Guide to 401(k) Accounts

3 Minute Read
Key Points
  • A 401(k) is a type of retirement account
  • Saving money for retirement prepares you for your future
  • It’s never too late to start saving

401(k) accounts can be scary and confusing for many people, especially if you do not know exactly what they are. A simple guide to 401(k) accounts, we will cover what it’s all about.

What Is A 401(k) Plan?

To put it into very simple terms, a 401(k) account is quite similar to that of a savings account. You put a certain amount of money into it on a regular basis, to begin building it up. However, instead of taking it out on a rainy day, the money is saved for when you are ready and eligible to retire.

Because it is so similar to a regular savings account, many people ask why they cannot just simply use a savings account to do the same thing. There is one big reason as to why having a 401(k) account is so important.

In the USA everybody is expected to pay income taxes. However, by putting some of your earnings into a 401(k) it helps to defer some of your income until later on in your life. Any money that you put into your account is not taxed (right now). Thus, meaning that the more money that you feed into your account this year, the less you are going to pay in income taxes. A savings account does not work like this, you will still have to pay the same amount of income taxes.

However, just because you do not pay tax on this money right now, it does not mean you never will. When you take this money out in retirement, you will have to pay a certain amount of taxes on it.

Some employers are even offering matching funds for any and all employees who contribute to the companies 401(k) plan. So, you need to double check if this is something that your own employer is offering and take advantage of it. Even matching a small percentage is like putting free money into your account for retirement.

How Do You Withdraw Money From Your 401(k)?

Once you retire, you are able to then begin withdrawing the money from your 401(k) account. There are quite a few different ways that you can withdraw this money, you just need to decide which is the easiest and most convenient for you. For example, you can access the money through a direct deposit every other week or every month, or you can receive it through a check in the mail. It is entirely up to you.

It is important to note the exact amount of money that is in your account before anything is withdrawn. That way you can then withdraw around 4% of that value every year. Which, more often than not will give you a reasonable amount of money in your bank. Even after the taxes have been taken, which is also something that you do not have to worry about because the majority of the time the company, that your account is with, will have them handled for you.

A Solo 401(k) For Entrepreneurs

A Solo 401(k) plan is a 401(k) qualified retirement plan that was designed for self-employed individuals and small business owners with no full-time employees, excluding a business partner and spouse. Much like the traditional 401(k), this unique plan encourages individuals to save for retirement in a tax-advantaged environment. When participants contribute funds into the Solo 401(k), taxes on the funds will be deferred until the participant takes a qualified distribution.

The Solo 401(k) is an IRS-approved plan that has the same rules and requirements as a traditional employer-sponsored 401(k). However, the Solo 401(k) allows participants to make annual contributions to the plan as both an employee and employer, which ultimately increases the yearly maximum contribution limit.

Also known as a self-employed 401(k) or individual 401(k), individuals can benefit even if they generate a portion of their total income through self-employment activities, such as a freelance gig. 

However you save for retirement, it’s important to start early, be consistent, and trust the process.

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