401(k) Plans Can Reduce Your Taxes - dummies

401(k) Plans Can Reduce Your Taxes

By Paul Mladjenovic

Company-sponsored 401(k) plans (named after the section in the tax code that allows them) are widely used and very popular. In a 401(k) plan, companies set aside money from their employees’ paychecks that employees can use to invest for retirement.

Generally, in 2012 you can invest as much as $17,000 of your pretax earned income and have it grow tax-deferred. Those over age 50 can contribute more as a “catch-up” contribution. For 2013 and beyond, check with the IRS and/or your tax advisor.

Usually, the money is put in mutual funds administered through a mutual fund company or an insurance firm.

Because your money is in a mutual fund that may invest in stocks, take an active role in finding out the mutual funds in which you’re allowed to invest. Most plans offer several types of stock mutual funds. Use your growing knowledge about stocks to make more informed choices about your 401(k) plan options. For more information on 401(k) and other retirement plans, check out IRS Publication 560.

If you’re an employee, you can also find out more about retirement plans from the Department of Labor.

Keep in mind that a mutual fund is only as good as what it invests in. Ask the plan administrator some questions about the funds and the types of stocks the plan invests in. Are the stocks defensive or cyclical? Are they large cap or small cap?

If you don’t make an informed choice about the investments in your plan, someone else will (such as the plan administrator), and that someone probably doesn’t have the same ideas about your money that you do.