Retirement Investing

401K Investing: IRS Guidelines, Tax And Retirement Plans

In 1978 the US congress discussed a range of initiatives to encourage individuals to save funds for retirement. The Tax Reform Act was passed and came into effect in 1981. This Act was designed to encourage savings and to lower exposure to state and federal income taxes. 401 K investing plans are defined contribution plans by either the employer or employee and enjoys tax deferred status.

401 K investing involves specifying to your employer the amount of money you wish to deduct and contribute on a monthly basis. The IRS specifies the limit that individuals can contribute to 401 K retirement plans. This amount is removed prior to taxation (pre-tax 401K investing). In some cases, employers have contribution plans which match your amount either dollar for dollar or on a percentage basis. These funds are not meant to be withdrawn until the eligibility age of 59 1/2 is reached without incurring taxation and an IRS penalty rates.The money is held through a custodial account which insulates the funds from any adverse business performance. The funds deducted are managed by a third party who invests the money in stocks, bonds or money market accounts.

The advantage to 401 K investing is that the money is removed prior to tax. This has an effect of offsetting tax by diverting the funds for investment purposes. Although your take home pay will be lower, you are shifting money that will compound over time as opposed to paying tax to the IRS that you will never see again. If you are not an experienced investor, 401K investing is a great place to start because you do not require any serious degree of investment knowledge and the process is automated once setup.

The other advantage of 401K investments is that this amount can be borrowed against in the event of an emergency. Although you will pay interest, you are effectively paying this amount to yourself. Investing in your 401K is an investment in your future.

So how much should you contribute to a 401 K retirement plan? This depends on your take home pay, your other investment initiatives, the state of the economy and your job security. In some cases where the employer contributes to your plan, you may be subject to a vesting schedule which increases your ownership of the funds contributed by your employer according to the length of your employment service. If you have a comfortable savings base and your job is secure then contributing then you can afford to be more aggressive with your contributions. A carefully thought out plan after considering your full financial status is the best way to proceed. For the most part, just getting started investing in 401K will pay off significantly in the long term.

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