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Using your 401k to save up for retirement can be a great idea. But what is a 401k? And how does it help the average person save up for retirement?

A 401k can help employees to put money into a tax defered account and have that money invested by professional money managers. In this plan the money can grow without having to pay any taxes on it until you take it out.

However there is also a maximum 401k contribution limit that is forced upon all 401k plans. This means that there is a limit each year on how much someone can invest into their plan. In addition to this some employers will also have some sort of limit on the amount of money someone can invest.

If your employer offers the plan then it is normally a wise idea to take advantage of it. And if your employer matches you or adds money to your plan every time you invest it becomes even better. In this case your employer will deposit more money into your account for every $1 that you invest into it.

The idea is that this money can be invested until you are at the age 59 ½ and start to take the money out to pay for your retirement. The 401k withdrawal rules don’t look kindly to people who want to take out some money from their account early.

If an employee tries to take money out of their account before they turn 59 ½ then they will be forced to pay not only the taxes on the money, but also a 10% early withdrawal fee. That is why it is normally better to wait until you actually retire or are at least 59 ½ before taking money out.

Once they reach this age they are able to take money out without paying the 10% penalty, but they would still have to pay taxes. After all the investment was tax deferred not tax free.