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Frequently Asked Questions: 401(k)

It is an important source of pension benefits at retirement.
For many people, this is the only source of pension benefits at retirement other than pension benefits from Social Security. As you know, Social Security only provides the basic pension benefits at retirement. For example, the maximum monthly pension benefits from Social Security for 2004 ranges from $1,422 for a person retiring at age 62 to $2,111 for a person retiring at age 70. Most retirees do not receive the maximum monthly pension benefits. The average monthly pension benefits from Social Security for January 2004 is $922. Use 401(k) to supplement your pension benefits at retirement.

It is one of the best ways to save for retirement.
Everyone is trying to help you! Maybe not everyone, but Uncle Sam is. Your contributions towards a 401(k) plan are tax deductible. Investment earnings are tax free during the accumulation period.

Receive additional money from your employer.
Your employer is also trying to help you! Most employers add contributions to your account if you participate in a 401(k) plan. On average, employers match 50% of every dollar you save for retirement, up to 6% of pay. This means that, for every dollar you put in, your employer will add 50 cents to your retirement account, an immediate 50% gain on your savings. You should maximize your employer contributions if you can. This is part of your compensation for your service. Do not leave it on the table!

Compound interest can significantly increase the amount of your pension benefits at retirement.
In our related article, "How to increase your 401(k) money", we showed you an example of an employee age 25, with an annual salary of $36,000, contributes 6% of pay to a 401(k) plan. His/her employer adds another 50 cents for each dollar he/she saved. Assuming his/her pay stays the same, he/she would have saved $86,400, but will receive $839,300 at age 65 -- almost 10 times of what he/she saved! Here is a breakdown:

Help from Amount 
Yourself ($2,160 x 40 years): $86,400 
Your Employer ($1,080 x 40 years): $43,200 
Compound interest (at the rate of 8%): $709,700 
Total: $839,300 

You are responsible for investing your 401(k) money.
Most 401(k) plans offer you many investment options with which you can invest your 401(k) money. Invest wisely, as 1% extra in investment earnings will result in a signicant increase in your 401(k) money. The numbers in the above example look very attractive when the investment return rate is increased by 1%:

Help from Amount 
Yourself ($2,160 x 40 years): $86,400 
Your Employer ($1,080 x 40 years): $43,200 
Compound interest (at the rate of 9%): $965,100 
Total: $1,094,700 

In this example, you receive an additional quarter million ($1,094,700 - $839,300 = $255,400) when your investment return is increased by just 1%. It is worth your time to learn how to invest wisely.