Boston College's 401(k) Page

Frequently Asked Questions about 401(k) Plans:

 

What is a 401(k) plan?

    A 401 ( k) is a type of retirement plan that allows employees to save and invest for their own retirement. Through a 401(k), you can authorize your employer to deduct a certain amount of money from your paycheck before taxes are calculated, and to invest it in the 401(k) plan. Your money is invested in investment options that you choose from the ones offered through your company's plan. The federal government established the 401(k) in 1981 with special tax advantages, to encourage people to prepare for retirement. They get their catchy name from the section of the Internal Revenue Code which established them (you guessed it, section 401(k)).

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How does a 401(k) plan work?

    You decide how much money you want deducted from your paycheck and invested during each pay period, up to the legal maximum (the IRS sets an annual dollar limit each year). You also decide how to invest that money, choosing from your plan's different investment options. The money you contribute to your 401(k) account is deducted from your pay before income taxes are taken out. This means that by contributing to a 401(k), you can actually lower the amount you pay each pay period in current taxes. For example, if you earn $1,000 each paycheck, and you contribute, say 5% ($50), you are only taxed $950. You don't owe income taxes on the money until you withdraw it from the plan, when you could be in a lower tax bracket.

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What's the difference between investing money in my company's retirement plan and investing in a mutual fund or bank account?

    Taxes, taxes, taxes! An ordinary savings account or mutual fund doesn't allow you to save on a tax-deferred basis. So in an ordinary savings account your money that has already been taxed, and you continue to pay tax on the earnings of that account, too. The money you contribute to your company's 401(k) plan, however, comes out of your paycheck before taxes are taken out. Plus, you don't pay income tax on the money you contribute to your 401(k) account or on any earnings until you take it out, which is usually at retirement, when you may be in a lower tax bracket. The bottom line: More of your money is working for you instead going toward taxes. Keep in mind, however, that investing in your company's retirement plan is only a part of a sound retirement saving plan. It is still important to have personal savings aside from your retirement savings, too.

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