What is a 401K and When is the Best Time to Start One?

Whether you’ve been in the workforce for a year or 50 years, you should most definitely be thinking about saving for retirement. A little goes a long way, especially if you start early. A 401K is just one of the many options that can help you plan ahead for your retirement and save responsibly.

Below are some factors you may want to consider when deciding to participate or opt out of a 401K plan.

Tax and Savings Benefits

A 401K is a type of retirement savings account that is sometimes offered in employee benefits packages. Although there are other types of retirement savings options you can use on your own, a 401K is the only one that is employer sponsored. Not all employers are required to offer 401K plans, but if your employer does—you should seriously consider utilizing it.

Unlike a regular savings account, a 401K is “tax-deferred”, meaning both you and your employer can place money in the fund without paying taxes on it at that time. Each time you receive a paycheck, income taxes are withheld—but when money is placed automatically into your 401K from your paycheck, it isn’t taxed.

You are the one to choose exactly how much you want to contribute to your account per paycheck, and then it’s done automatically before it ever passes to you. This has two more major benefits. First, you won’t even know that the money is gone and have the chance to spend it on something other than retirement, and second, you get to reduce the earned income you report on your tax return—meaning you’ll pay less in taxes each year you contribute!

For example, if you usually make $40,000 a year, but you decide to invest 10% of each paycheck in your 401K, you would only need to report an earned income of $36,000 on your tax return.

Tax Concerns and Penalties

Unfortunately, no investment system comes without risk. If you withdraw money from your 401K too early or take large amounts out in one transaction, you could be subject to heavy fees and taxes. Additionally, money will always be taxed at the time you withdraw it and because the federal tax bracket is always fluctuating, there’s no way to know whether it will be higher or lower by the time you retire.

If you are concerned about federal tax fluctuations, the potential of early retirement, or needing to withdraw lots of money at a time, you may want to consider other retirement options, such as an individual savings account or a Roth IRA.

Most importantly, you need to consider and weigh your short-term and long-term financial goals to ensure balance.

Short-Term and Long-Term Financial Needs

Before you contribute to a 401K, it’s crucial to have a secure financial safety net such as an emergency fund, as well as control over debts and loans. An emergency fund that is easily accessible in times of crises is a more pressing need than a 401K because the immediate future is just as important to budget for as the distant future.

If you expect to have loans, unsecured debt, or potential high costs in the near future, now may not be the time to contribute to a 401K. Ultimately, only you can decide what’s best for your future and New Era Debt solutions can help you move towards your financial goals.

401K FAQs

What is a Roth 401K?

A Roth 401k is a type of retirement savings plant that combines features of a traditional 401k and a Roth IRA. The unique aspect of Roth 401k’s is that they allow employees to make after-tax contributions to the plan, where contributions are taxes in the year they are made, but the earnings and withdrawals from the Roth 401k are tax-free in retirement.

The Roth 401k was named after Senator William Roth who introduced legislation that created it in 1997, and since then, this type of plan has become increasingly more popular as Americans seek tax diversification in their retirement savings.

How Much Can I Contribute to a 401K Annually?

The amount that can be contributed to a 401k changes from year to year through a process conducted by the IRS, with this limit having increased the last few years due to inflation. In 2023, the contribution limit for those under the age of 50 is $22,500 and $30,500 for those 50 and over.

If you have a 401k, it’s a good idea to review these contribution limits each year to ensure you are getting the most of your contribution schedule.

Retire Without the Hassles of Debt

New Era Debt Solutions has settled over a quarter of a billion dollars of debt since 1999 and wants you to be our next success story. If you need assistance in achieving financial freedom, contact one of our friendly counselors at New Era Debt Solutions to learn more about finding the debt relief option that best fits your needs and budget. Our counselors are with you every step of the way.