Even if your employer doesn't offer matching contributions, the tax advantages of a k still make this one of the best ways to save money for retirement. Tax-Deferred Earnings When you contribute a percentage of your pay to a k plan, you immediately start paying less to Uncle Sam. That's because your contribution comes out of your paycheck before income taxes are deducted. That means your taxable income is less, which in turn lowers your tax bill.
Thus, you "defer" or postpone paying income tax on your k savings and any investment earnings they may accumulate until you withdraw the money at retirement. For many people, their income - and therefore income tax rate - is lower at retirement, so they're paying a smaller amount of tax on the money. Plus, if you happen to retire to a state that has no or very low state income tax, you'll be that much further ahead.
Loans Many plans allow you to borrow from your account for specific reasons, such as buying a primary residence, paying for education or medical expenses, or in case of severe economic hardship. A loan usually must be paid back with interest within five years although this may be extended for a home purchase , and as long as you remain employed by the company, you can pay it back without incurring any income tax liability.
The interest you pay goes directly into your account. When withdrawing money from your plan, carefully consider the options available to you including rolling your money over to another qualified account to avoid potential tax penalties. Please note: Financial advice should be tailored to individual circumstances and the content of this article should not be viewed as recommendations.
This article is not an endorsement of any particular product, service or organization; nor is it intended to provide financial, tax or legal advice. It is intended to promote awareness and is for educational purposes only. The specific applications and services noted are not necessarily endorsed by John Hancock or any of its affiliated businesses.
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Here are 5 benefits of most traditional k plans:. First, your contributions are tax-deductible. The money you contribute doesn't count toward your gross income for the year, lowering your taxable income. Second, your money grows tax-deferred. If you saved money in a savings account or brokerage account you would have to pay taxes on your interest or dividends at the end of the year. With a k plan, your earnings are rolled back into the plan and don't have to be listed as income on your tax return until you withdraw them.
Your savings grow faster this way. Three More: Good Strategies 4. Interest compounding. This can be a difficult concept for new k savers to grasp, but it's what makes a k plan a powerful savings tool.
Put simply, your earnings are plowed back in to the account so you earn interest on your original principal plus interest. Over the short term, the gains can appear small. But over the long term, you can see exponential results. For example, take the number two and double it, then double that number, and again. After you have doubled two only 10 times you reach 2, Interest compounding works the same way. Assuming an eight percent average return, you can reasonably expect a one-time k savings contribution to double every seven years.
If you consider most folks have at least a year working life, their initial contributions could double at least five times. All of our content is authored by highly qualified professionals and edited by subject matter experts , who ensure everything we publish is objective, accurate and trustworthy. Our reporters and editors focus on the points consumers care about most — how to save for retirement, understanding the types of accounts, how to choose investments and more — so you can feel confident when planning for your future.
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