Retirement Basics: 401K
Employee retirement plans have gone through a huge change in the past few years. A few decades ago, there were no retirement plans in place. Instead, there were pension plans. This meant that the employer would pay a certain amount of income to their employees in their old age till the day they or their spouse were alive. This type of plan was called the defined benefit plan, wherein the employer was supposed to provide their employee with agreed-upon benefits.
However, it is important to note that life expectancy was very short at that time. Very few people lived to see even their sixties. This is the reason that the employers could afford to pay a pension. However, with the advancement in science, life expectancy went up. As a result, the amount of money being spent on pension also started going up. In order to reduce this amount being spent on pension, a new type of retirement plan was thought of.
This relatively new type of retirement plan is called a defined contribution plan. This is because, as per this plan, the employers obligation ends when they make a contribution to the plan. The amount of money received by the employee may be more or less depending upon external factors. 401(k) is a type of defined contribution plan. It is the most widely used investment vehicle across the United States for retirement planning.
In this article, we will have a closer look at how 401(k) works.
What is a 401K Plan?
As mentioned above, the 401(k) plan is a plan which is created to ensure that employees have enough money during their retirement years. Since this plan is meant for the retirement years, the most important thing is that the withdrawal of money is restricted. Hence, in an average mutual fund, you can invest your money or take it out at will. However, when it comes to 401(k), there is a penalty on withdrawing the funds before reaching the age of 59 years and six months.
The plan takes its name from section 401(k) of the Internal Revenue Services act, which makes special provisions and allows tax breaks for people who want to save for their retirement. The government wants people to be able to fund their own retirement. This is because if they are not able to do so, then the government has to partially take care of some of these people in their old age.
Benefits of 401K Plans
401(k) plans have several benefits. Some of these benefits have been explained in this article.
Disadvantages of 401K Plans
There are some disadvantages of 401(k) plans as well. They have been listed below:
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