Preparing for a Stable Future with your 401k

One of the most common questions to a human resource specialist is, "what benefit does my 401k provide?" A 401k is a legal savings option provided in the tax code. It is also one of the many ways your employer compensates you each year. 401k options have been created to help you plan for retirement effectively.

Tax Free Contributions

The biggest benefit to these retirement plans is that you may use tax free dollars to invest in them. You contribute directly to your 401k each paycheck, and the monies are not taxed until you withdraw. For example, if your gross income is $3000. and you invest 10%; your contribution will be $30. even if your take home is $2500. This tax savings can add up to provide you with a nice retirement account.

Employer Matching

Your employer may offer to match your contribution up to a certain level. This amounts to an additional thousands of dollars in compensation each year you will not claim if you are not making maximum contributions. Essentially, employer matches are free money and a perk of the company.

Retirement Payout

Once you reach the age of 59 1/2, you will be eligible to receive payments from your 401k to assist you in retiring or planning for retirement. With life expectancy increasing, you may have to provide for yourself for 30 or more years after you reach the age of 60. These savings can be instrumental in allowing you to retire and not work during those golden years.

Do you have to claim income from your 401k withdrawals on your tax return?

Any time you take 401k withdrawals from your retirement account, you will owe income taxes on the withdrawal. The only exception is with certain Roth 401k plans where taxes were already paid on the front end rather than deferred to the back end. On traditional 401k's, however, the income tax is applied on the back end, even if you have reached qualified age or are taking a mandatory withdrawal. If you take a withdrawal before minimum qualified age, you will face a 10 percent penalty in addition to the income tax charged on the amount withdrawn.

How much are your 401k withdrawals taxed?

The amount of tax you pay on 401k withdrawals depends on your income level at the time you take money from your account. Your federal income tax rate is set based on your total income for a given year, including your 401k withdrawals. You do not pay taxes at the time you withdraw the money. Instead, you report the income on your year-end statement and pay taxes at this point. As a result, it is wise to make estimated tax payments to the IRS anytime you withdraw money from your 401k. For allowable distributions, estimate taxes at your current tax rate. Add a 10 percent penalty payment for any early withdrawal.  

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