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Why you should have a 401(k)

Gifts from Uncle Sam are rare. But there is one gift he gives that keeps on giving, and you should take advantage of it – a 401(k).

If someone offered you free money, would you refuse it? Probably not. But that's just what you are doing if you don't contribute to your 401(k). The more you contribute, the more free money you get. 

Here's why: Contributing part of your salary to a 401(k) gives you three compelling benefits: you get an immediate tax break, possible matching contribution from your employer and tax-deferred growth. The federal limit on annual contributions has been increasing gradually, and is $16,500 for the 2010 tax year. If you're 50 or older, you can contribute an additional $5,500.

Keep in mind, however, that while federal law sets the guidelines for what's permissible in 401(k) plans, your employer may set tighter restrictions. What's more, there are other federal non-discrimination tests a 401(k) plan must meet, one of which applies to highly-compensated employees. So if you make more than $110,000 a year, you may not be permitted to contribute as high a percentage of your salary as some of your lower paid colleagues.

For all of its tax advantages, the 401(k) is not a penalty-free ride. Pull money from your account before age 59 1/2, and with a few exceptions, you'll owe income taxes on the amount withdrawn, plus an additional 10 percent penalty. 

Also, be aware of your plans vesting schedule – the time you're required to be at the company before you're allowed to walk away with 100 percent of our employer matches. Of course, any money you contribute to a 401(k) is yours.

How much should you contribute to your 401(k)? For starters, figure out how much you need to save. If you're just starting to plan for retirement at age 40, you'll need to put away more than if you were 25. Typically, experts recommend you save at least 10 percent of your income. Check to see if your employer will match your contributions if your 401(k) is through your employer.

Published Oct 28 2010, 01:01 PM by moneycoach
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