401k is most popular employer sponsored retirement plan in USA. Millions of American workforce use this fund as a means of their retirement fund. Because of its flexibility and some other popular features, 401k retirement plan has become number one retirement plan in USA.
Even though 401k is highly flexible for both employees and employers, Employee should be careful when choosing the 401k. Otherwise, 401k plan could cost them extra money
First thing one needs to know is employer match. Employer match is free money for employee. Employee should take maximum benefit from employer match.
For example, Allen works for X company. The company offer maximum 4% employer match up to 4% of salary. Allen should contribute at least 4% for her salary for 401k.
Let say, Allen 4% salary is $200 per month. Her total 401k contribution with company match would be= (200 +200) = $400.
Her 401k contribution is $400 every month even though she is contributing $200 each month. This way, She is doubling her 401k money by contributing 4% of her salary each time.
Another example, Ryan works for Y company. His company offer 3% employer match up to the 6% her salary.
Ryan must contribute 6% of his for 401k to get maximum match 3% from his employer. In this case, every 1% increase in employee contribution will be match with .5% employer benefit.
3rd example is, Kelly is an employee of Z company. His company offer maximum $500 match to the employee salary.
Kelly must contribute at least $500 of his salary regardless of percentile of his salary. So, Kelly can maximize his salary by contributing $500 each month. His total 401k contribution would be $1000 with company match even though she is contributing 500 each month.
However, if Kelly contribute 300 each month, his total contribution with company match would be $600. She is not taking full advantage of company match.
Employer match is also known as free money. Do not leave them on the table.
Employee should look at the fund fee when they decide which fund to invest. Fund fee in the long horizon adds up a lot of money.
Try to contribute maximum amount to 401k. one advantage is you are saving more. Another advantage is you are paying less tax to your salary.
For example, let say you contribute $500 each month to 401k. Because of $500 deduction in 401k , your tax bucket has changed from 25% to 20%. At the you will have two fold advantage.
First, you are paying less money as tax. Second, because of lower tax bracket, you tax deduction rate will be 20% instead of 25%.
Maximize the 401k limit:
Fed set the limit for 401k contribution each year. Currently maximum 401k contribution limit is $18000 each year. Catch up contribution limit is $24000 if you are 50 years or older.
One advantage of maximizing 401k is tax advantage. You will pay less tax by putting more money in the 401k. Another point is taking advantage of compounding interest rate in the long horizon.