In order for you to better understand what a 401(K) is, let me first explain its origins. The 401(K) was first introduced in 1982. It is named after the section of the federal tax code, section 401, paragraph (K). This section gives the plan its tax advantage status. That advantage being, any money you put into the plan is withdrawn from your paycheck automatically before the IRS taxes your wages. Those contributions are not tax-free however. They are tax-deferred. Tax-deferred means that all your contributions and subsequent money earned through investment options, will not be taxed until it is withdrawn. You can begin making withdrawals when you reach 59 1/2 years old, at which point you will be taxed based on your ordinary income rate which is typically lower during retirement.

Still not sold? Another consideration is that most employers will contribute somewhere between .25-$1.00 for every $1.00 you save. This will generally have a cap though, so be sure to consult your employer’s 401(K) representative for details. Either way, free money is free money!

If you find yourself changing jobs, you have a few options with regard to your 401(K) account…

• Leave It: If your balance is more than $5,000 you have the option to leave it with your former employer’s 401(K) plan. You will not be able to make further contributions, but your money will continue to grow based on the investment options you have selected with your plan.

• Transfer It: If your new employer has a 401(K) plan, you can request that your former employer transfer your funds into your new plan. This option will ensure that the money will not be taxed by the IRS as it never touched your hands.

• Roll It Over: Another option is to take a distribution check from your former employer and roll it over into a new 401(K) or an Individual Retirement Account (IRA). Unfortunately with this option, your former employer will withhold 20% for tax purposes. Also, you only have 60 days to deposit your money before the IRS hits you with taxes and penalties.

• Keep It: If you decide to keep the funds from your 401(K) plan you will be taxed based on the amount of money you withdrawal and a 10% penalty will be imposed. This is probably not your best option!

How much to save? Generally speaking, you should save as much as your employer will match if your current spending plan can handle it. So if your employer will contribute .75 for every $1.00 you save up to 3% of your salary, then save 3%. If your spending plan can’t handle this, contribute what you can and commit to increasing the percentage upon receiving a raise or promotion. Another smart option if your employer gives annual bonuses is to deposit half into your 401(K) and keep the rest. It’s a win, win scenario! You get discretionary income, and your retirement account gets a nice fat deposit!

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