In the United States, a 401(k) plan is a savings plan for retirement that can be established for an employee by their employer if they meet eligibility requirements. The Internal Revenue Service sets contribution levels for 401(k) plans that can change over time and growth in a 401(k) fund is not subject to capital gains tax.
When deciding how to invest in a 401(k) plan, you will first need to choose between the two basic types. Regular 401(k) plans allow employees to make contributions before taxes are assessed, and disbursements from the account are then taxed when withdrawn.
Alternatively, Roth 401(k) plans allow after tax contributions to be made, and disbursements are then withdrawn from the account tax free. Accordingly, you will want to take into account whether your tax bracket now is lower or higher than you expect it to be when you anticipate making the bulk of your withdrawals.
Another key aspect of how to invest in a 401(k) involves deciding how your contributed funds are to be allocated among the various investment choices that your employer’s plan offers. A variety of mutual funds are some of the most popular options selected by employers for their staff’s 401(k) plans.
When considering how to allocate assets among different mutual funds, a more aggressive investor looking for growth will tend to place a higher percentage of their 401(k) portfolio in large, medium and small cap stock mutual funds that invest primarily in companies with market capitalization levels ranging from $300 million to over $10 Billion.
On the other hand, a more conservative investor seeking preservation of capital and a more modest income might instead choose bond funds that tend to be less risky than stocks. They might also allocate a considerable portion of their 401(k) portfolio to cash and short term fixed income investments that are highly liquid, less risky and offer a lower, but more secure, income.