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Why Contribute to a 401k Plan?

More and more employers are offering defined contribution 401(k) retirement plans to their employees. A 401(k) plan allows participating employees to elect to defer a percentage of their pay into the plan on a pre-tax basis, up to a 2015 maximum of $18,000. Participants age 50 and older may also be able to make "catch up" contributions of up to $6,000 in 2015. These amounts may increase periodically.

In addition, many employers match employee salary deferrals in some way. Employer contributions, along with those of the employee, are placed in a special retirement account for the employee where they have the potential to grow on a tax-deferred basis until retirement. Plan participants usually choose how they want to allocate their assets among the investment choices offered by the plan. Employees' contributions are always their own (i.e., they are immediately "vested"), and employer matching funds may become vested (owned by the employee) after remaining in the plan for a specific number of years.

Some of the advantages of contributing to your company's 401(k) plan include:

  • Easy and convenient payroll deductions. Contributing to any savings plan before you actually receive the money is one of the most painless ways to save and invest. When you join a 401(k), you decide (up to a specified maximum) how much will be withheld from your paycheck and contributed to your plan account each pay period.
  • Pre-tax savings. Your 401(k) contributions may be made on a before-tax basis. By contributing to the plan on a pre-tax basis, you are reducing your federal taxable income.
  • Tax-deferred savings. Your contributions, any employer contributions and any earnings on these contributions can grow on a tax-deferred basis. This means you don't pay taxes on the money in your account until it is withdrawn. The compounding effect of tax-deferred growth can be a powerful way to build a retirement fund for your future. Note, however, that withdrawals before age 59½ may incur a 10% federal penalty in addition to applicable income taxes.
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