What Is a 401k Plan?

For most people, a workplace 401(k) or similar retirement plan is their primary retirement savings vehicle. Yet the question, “What is a 401k plan?” can still be hard to answer. Retiring isn’t quite as easy as it once was.

The defined benefit pension plans of your parents’ and grandparents’ generations are largely a thing of the past — according to the Social Security Administration, the proportion of private and salary workers between 1980 through 2008 fell from 38 to 20 percent. Fewer private sector employers now offer pensions and many public sector pensions have funding issues (according to the Pew Charitable Trusts, states were coming up on a $1 trillion shortfall in 2014, the most recent fiscal year available). Social Security may or may not be an option for millennials and Gen Xers.

These days, many people in the workforce are planning to be responsible for funding their own retirement. So, exactly what is a 401(k) plan and how can you be sure your money is working for you?

1. Educate and Empower Yourself

Start by understanding what a 401(k) plan is and how to take advantage of it. A 401(k) plan is an employer-sponsored plan that puts money toward your retirement savings. You contribute a portion of your salary and the money gets invested in one or more options offered by the plan. Contributions are made on a pretax basis, meaning that the money contributed reduces the amount of federal and state income tax withheld from your paycheck. Your money grows on a tax-deferred basis and isn’t taxed until you withdraw from your account.

Some 401(k) plans also offer a Roth IRA option, which is a personal retirement savings plan. Your contributions are made on a post-tax basis, meaning there are no current tax savings. But when you withdraw money down the road, there are no income taxes to pay as long you meet certain requirements.

If you’re uncomfortable making your own investment decisions, don’t worry. Many plans offer advising options and even professionally managed accounts.

2. Contribute as Much as You Can

According to The Simple Dollar, the amount you contribute to your retirement plan is the most important factor in accumulating a sizable account balance. “Your early returns won’t have much of an impact on how much money you end up with,” notes The Simple Dollar. Start saving with as much as you can and slowly increase that amount over time. For those under 50, the salary deferral limit is $18,000, with an additional $6,000 catch-up contribution available for those who will be 50 or older during the year, according to the IRS.

3. Review Your Statements

Most 401(k) plans generate participant account statements quarterly in addition to offering daily access to your account online. When reviewing your statement, verify that all contributions have been properly credited to your account and money is allocated to the investment options you chose. Be sure to review this at least once per year to make sure it’s in line with your goals.

Your plan is required to disclose the costs of the investment options offered. This should also be reviewed regularly. Statements will generally report the performance of the investment options relative to funds with a similar investment objective or in the same asset class. While past performance is not an indicator of what might happen in the future, a fund that consistently underperforms other funds in their asset class should raise a red flag and cause you to dig deeper into the fund. Many plans offer access to tools on their sites that are loaded with information.

The 401(k) plan has become the primary retirement savings vehicle for most people today. You’re responsible for funding your own retirement, so it’s important to become an informed investor and monitor your 401(k) account and other investment accounts with diligence.

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