Getting the most out of your 401k plan

I recently started a small business of dry-cleaning and laundry services and wish to invest in a good plan such as 401 (k). Are there any tax benefits that I would obtain if I opt for the 401 (k)? When do I actually pay taxes in such a plan? – John Green

Hi John. You essentially supply “pretax dollars” to 401(k)s and similar predefined financial savings plans. This means that the contributions made by you are collected from your monthly paycheck prior to the deduction of tax.

That indicates that when you make a contribution to a 401(k), you are actually lowering the income amount that you need to consider for paying your taxes. This can ease the blow suffered by your take-home salary.

For instance, when your 401(k) gets a $100 contribution from your end every month, you will find your salary check amounts getting reduced by around 60 to 80 dollars every month. The precise amount will obviously vary basis your specific salary as well as the tax bracket you fall in.

In case you decide to make a tinier investment into a 401(k), or raise your investment by one percent each year, there are chances that you would find it hard to see any difference as far as your salary checks are concerned. Also, you will receive a lower tax bill.

Eventually of course, you would be required to pay taxes. But this will only happen once you retire. All withdrawals made by you are taxed by the IRS at the usual income tax rate.

However the catch is that if you decide to withdraw before the age of 59 and a half, you would be required to a 10 percent penalty for early withdrawal in addition to the due taxes, if any. Your fund could suffer a huge blow with that total amount and is typically not considered as a good idea.

When it is time to make withdrawals on a conventional defined investment plan such as the 401 (k), you would need to pay income taxes on a regular basis. This will be calculated on the money withdrawn by you, irrespective of whether the money was received from dividends, your contributions or capital gains.

For conventional plans, income tax will be due on all the withdrawals made, including the money contributed by you as well as the gains earned on those contributions. It is a good idea to handle your 401(k) account with the support of a small low-cost plan provider like 401k easy which makes it much simpler and a smoother process for you!