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Another benefit of the 401(k) is that your investment growth is tax deferred. This means that you don't pay annual taxes on your gains, until you begin taking withdrawals. With a standard, non-deferred, investment account, Uncle Sam gets his share via taxes each year. That's if you claim capital gains. The money the government takes each year reduces the amount you have in the account available for compounding. In a 401K, this is not the case. Old Sammy can't get his grubby fingers on the money you've saved until much later in life. This helps you take full advantage of long-term tax-deferred compounding.
A 401K plan also offers some measure of flexibility. It's a long-term investment intended to stay in your account until the age of 59 ˝, but you can take out a loan against the plan for a major purchase. There is no penalty if you pay it back. In fact, with a 401k loan, you are simply taking out a loan against yourself. Each month your salary is reduced by an additional amount, over and above your normal contribution, until the loan is paid off. The best part is that you are forced to pay yourself interest during the payback period. That way, you are still earning on your money. Pretty nifty, huh? However, keep in mind that you will be penalized 10% if you take out the loan and don't pay it back, plus income tax on the whole amount. Loans have to be repaid in five years with after tax money.
Are you ready for the grand finale? Probably the best part of a 401(k) is the employer contribution. Most plans are set up whereby the employer will match a certain percentage of the employee's contribution. Most employees will match .50 to every dollar and up to 6% of the total salary. For example, if you make $40,000 per year and contribute 6% per year, your contribution for the year would be $2,400, while the employee adds another $1,200. Amazing! They actually give you money. This equates to an AUTOMATIC RETURN ON YOUR MONEY UP FRONT. Go to your broker and try getting that deal. Do this year after year and you will find yourself sitting pretty in the long run. In fact, you'll probably find yourself sitting pretty on a sandy beach in sunny Florida, after enjoying 18 holes on the golf course day after day. Doesn't sound like a bad plan to me!
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