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Whether you’re planning to spend your retirement traveling or finally slowing down and relaxing at home, a retirement plan is essential. There are many different ways to save for retirement. One of the most popular retirement plans is a 401(k). We’ll break down what a 401(k) plan is and how it works. 

What is a 401(k) plan? 

Put simply, a 401(k) plan is like a savings account that you put money into for retirement. To contribute to this account, money is deducted from your paycheck. The money you save in the 401(k) plan grows over time, so when you retire, you can use that money to create an income stream through retirement.  

Once you add money to your 401(k) plan, you can choose how to invest it. You can choose to invest conservatively and earn a steady amount of return, or you can choose to be more aggressive and take on more risk with your funds. There are many different options for how you can invest your funds.  

Tax benefits of a 401(k) 

What makes a 401(k) plan different from a savings account? A 401(k) receives special tax benefits. The money that you put into your 401(k) is not taxed when you contribute to your plan. If you put money into your 401(k) plan this year, you will likely pay less in income taxes this year because any money deducted from your paycheck is “pretax.” You should consult a tax advisor to evaluate your specific situation and potential tax savings. 

Once you retire, you will have to pay taxes on the money that you take out of your 401(k). You’ll likely pay less in taxes then, since you’ll probably have a lower overall income at that point. If you choose to take money out before the age of 59 ½ , you’ll be taxed with a 10% early withdrawal penalty. Avoid losing a sizable chunk of money by waiting to make any withdrawals until after you’re 59 ½.  

Withdrawing funds for retirement 

When you retire, you can begin withdrawing money for your 401(k). Many plans provide options for withdrawals. Your options may include: choose to take a lump sum, receive bi-weekly or monthly paychecks from your plan, or a combination of the two. 

You can set up your withdrawals like a paycheck, either by getting a check in the mail or direct deposit. Work with the company that manages your 401(k) to set up how often you’ll receive the payments. The company will usually take care of deducting the taxes for you as well.  

Employer match 

Many companies that offer a 401(k) plan also offer a match program. This means that your employer will match the contribution you make up to a certain amount. For example, an employer may match your contributions up to 6% of your total salary. This can really add up over time. If your employer offers a match, be sure to take advantage to put extra money aside for your retirement. 

A 401(k) is a great way to save for retirement and offers a nice tax benefit. The flexible options of this plan make it easy to customize how you save for the future.