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Contributing
to Your 401(k)
If
you’re eligible for a 401(k) plan at work, you’re lucky. Contributions
you make to your 401(k) actually benefit from two tax breaks—one
up front, the other in the long term. First, the government allows
you to delay paying taxes on the money you contribute to a 401(k)
each year. So if you earn $30,000 in a year and you put $1,000
into a
401(k),
you’re taxed as if you had earned only $29,000 that year. The
$1,000 you put into the 401(k) is known as a before-tax contribution,
and you won’t have to pay tax on it until you start withdrawing
money from your account down the road. The other, longer-term
benefit of a 401(k) is that you get to delay paying taxes on the
interest
(or other earnings) your retirement account generates over the
years.
When
you withdraw the money at the time of your retirement,
you will pay taxes on the whole sum—the amount you contributed
plus your earnings. But because the money is able to grow untaxed
for many years, paying taxes later rather than sooner could result
in thousands of dollars more for you when you retire.
Most
companies allow employees to decide what percentage of their salaries
they want to contribute to a company retirement plan. In 2000,
the maximum amount of before-tax income an employee can
contribute to a 401(k) is $10,500. (Actually, the maximum you’re
permitted to contribute may be less, depending on factors such
as your salary and your employer’s contributions, if any, to your
plan.)
One
of the biggest benefits of a 401(k) is that many employers match
a portion of the amount you contribute with a contribution of
their own. Many companies contribute fifty cents for every dollar
you put in, up to a fixed maximum (often 3% to 6% of your salary).
That’s the equivalent of an immediate 50% return on your investment.
To take full advantage of this amazing deal, try to contribute
at least the maximum amount for which you are eligible to receive
matching funds.
Contributions
to 401(k)s are siphoned from your paycheck by your employer. After
a while, most people don’t even miss the money that’s being skimmed
off and discover that they’re saving money faster than they ever
thought possible.
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