Financial adviser: “We think you should begin to invest for your retirement as soon as possible. What you need now is to start a 401(k)!”
New employee: “A pair of designer jeans? I know they last well but how will that help me provide for myself in old age”?
Financial adviser: “No no, a 401(k) plan is a saving plan that allows you to invest for the future and defer some of the tax on those savings and the earnings now”.
New employee:” I’m suspicious of things that don’t tell me what they are up-front, especially big government things. What have they ever done for me, except tax me”?
Financial adviser: “It is good to be skeptical in money matters but participants who start a 401(k) plan do so through their employers. Always start a 401(k) that has proper amendments. This means you can put aside some or all of your contributions to a separate special ‘Roth’ account, commonly known as a Roth 401(k). Let me explain a little about starting a 401(k) plan and you see if you can come up with a better name for it. Ok?”
New employee: “Ok I guess, you’re the expert, but I don’t want to waste a lot of my time getting buried under paperwork. I don’t think starting a 401(k) would appeal to me even if you called it George Clooney!”
“So let’s see if we can’t change your mind. Qualifying investments from a designated Roth account are tax-free. This means that your contributions into them have the income tax withheld on the income in the year you contributed. So are your employers matching contributions because they are also putting money into your retirement investment fund?
In addition to Roth and pre-tax contributions, some participating employees may have after-tax contributions in their 401(k) accounts. The after-tax contributions are treated as after-tax and so may be withdrawn without tax. The growth on after-tax amounts not in a designated Roth account is taxed as income tax.
So to start a 401(k) is to gain in 3 important ways. 1) You are saving and investing in your future. 2) Your contributions are being matched by your employer and often this means investing in your employer too. 3) You are saving on tax payments.
Here is another non-sexy name for you. The ERISA or Employment Income Security Act of 1974 gives responsibility for managing your 401(k) investments to named trustees from within your employing company. So it is people like you looking after your money and making safe investment decisions. The investments are in a mixture of mutual funds but with reliance on low risk stocks and bonds. You can even have a say in which stocks to invest in”.
New employee: “Let me summarize. The 401(k) is safe long-term financial plan that is between my employer and me and gives me big tax deferments until I draw from the fund in my retirement. Hey! That sounds like a good deal all round. They should think about calling it George Clooney. They’re both amazing figures! And they’re both my idea of a dream come true!”