Planning for retirement is very essential for an NRI especially. An NRI has more options to choose from than most residents in India. So, they need to make wise decisions and choose the right plans while preparing for their retirement. One such retirement plan is the 401(k) plan which is not applicable for Indian residents but only for USA-based Non-Resident Indians (NRIs). 401(k) is an employer-sponsored retirement investment and savings plan that works only in the United States.
In this article, you will get to know all about the 401(k) retirement plan and how it can benefit you.
What Is 401(k)?
A 401(k) plan, popularly known as an employer-sponsored retirement and investment plan named after a section of the United States Internal Revenue Code. It is a defined contribution plan, which means it is completely up to the will of the employee as to how much they are willing to contribute to their account, subject to annual limitations.
Contributions made by the employee are directly withdrawn from their 401(k) account and invested in the funds of their choice. Employees can invest the money saved in their 401(k) account in one or more mutual funds offered by the plan.
How Does 401(k) Work?
 In general, there are 2 types of accounts under the 401(k) plan, mainly differentiated based on how they are being taxed.
Type 1
Type 2
Traditional account
Roth account
These are funded by pre-tax income
These are funded by post-tax income
Traditional Vs Roth Account
Traditional account
Roth account
Launched in 1978
Launched in 2006
Suitable for employees in a lower marginal tax bracket
Suitable for employees with a higher tax bracket
Employees near the age of retirement should go for traditional account
Young employees with low salaries now but likely to rise substantially in the future should go for Roth account
Advantage of an immediate tax break
Advantage of avoiding taxes later
Under a traditional account, you deduct contributions now and get tax-free withdrawals later
Under Roth account, you pay taxes on the contribution now and get tax-free withdrawals later
Functions like personalized pension account
Functions like a regular investment account
No age restrictions
No age restrictions
Penalty and tax-free after 5 years and age 59.5 years
Penalty-free but taxed as current income after the age of 59.5 years
No mandatory distributions required
Mandatory distributions after the age of 72
Tax-free withdrawals in the future
Advantage of tax benefit since the day of purchase
401(k) Investment Options
A typical 401(k) plan offers a wide range of investments, but any single plan might or might not offer all possible types of investments.
Even though a 401(k) investment plan comes with a variety of options like:
Company stocks
Individual stocks
Bonds
Securities
Variable annuities and much more.
Still, the one that rules the 401(k) investment opportunities is Mutual Funds.
Types Of Mutual Funds Under 401(k) Investments
Mutual funds are the most common 401(k) investment options. The most common Mutual Funds investment options include:
Mutual Funds
Features
Stock mutual funds
May have specified themes, such as value stocks or dividend stocks
Bond mutual funds
May feature specific kinds of bonds, such as short-term or intermediate-term
Target-date mutual funds
Includes both, stocks and bonds. Allocation keeps shifting based on specific target date or based on your retirement plan
Stable value mutual funds
Investment is made in safe assets, such as medium-term or government bonds. Returns and principal are insured against loss. Beneficial for investors near retirement
Range Of Mutual Funds Under 401(K) Investments
The abovementioned mutual funds range from conservative to aggressive, along with many grades in between. All the major financial companies use these similar terms while talking about the Mutual Fund range.
Let us look at the different range of fund types offered under 401(k) investments
Fund Types
Features
Conservative Funds
Avoids risks invests in high-quality bonds and other safe investments money grows slowly minimal chance of facing loss stable value funds come under conservative funds
Value Funds
The fund is in the middle of the risk range invests in solid, stable corporations that are undervalued companies usually pay dividends growth is expected moderately
Balanced Funds
Funds include more risky equities mostly includes value stocks and safe bonds balanced means medium risk involved in investment holdings
Aggressive Growth Funds
As the name suggests, funds include high risk-taking value funds can swing between high profits and great losses suitable for people willing to take the extra risk and have huge capital to invest
Specialized Funds
These are the funds investing in emerging markets, utilities, new technologies, or pharmaceuticals
Target-Date Funds
Includes both, stocks and bonds allocation keeps shifting based on specific target date or based on your retirement plan intends to maximize investment at a particular time investment moves towards the conservative end of the investment
How To Build 401(k) Portfolio?
Instead of investing all your money in one particular fund, it is always considered better to allocate your money around different funds. Allocation of money in different funds increases the probability of better returns. However, it is up to you to decide where and when to invest.
Here are some of the key factors that should be considered before you invest in a 401(k) plan
Financial Goals
It is important to differentiate between how much money you are willing to invest and take the risk upon. The sooner you start investing, the less you have to save to reach your goals later in life.
Diversification Of Funds
Diversification helps in capturing better returns in the end. Investing in mixed investments like stocks, bonds, commodities, and others, while maintaining balance is the best way to diversify your portfolio.
Assessing Risk Tolerance
One should always plan to take risks suitable to their portfolio. Higher the risk, more chances of profits and losses equally.
Time Horizon
More time until you need the money means you can take more risks and generate higher returns. This means that you should invest in such a way that you have ample time to recover if at loss.
Minimize Expense Ratio
You should avoid buying funds with high fees. It is always recommended that in case of options available, one should opt for the lowest cost option, which is an index fund.
The Bottom Line
401(k) retirement plan is beneficial not just at the time of retirement but throughout. It is an investment option that can help you not just to save your money but also grow it over years.
As the 401(k) investment plan comes with dynamic features and benefits, you need to make a wise and informed decision to avail of maximum benefits at the end.
˜Top 5 plans based on annualized premium, for bookings made in the first 6 months of FY 24-25. Policybazaar does not endorse, rate or recommend any particular insurer or insurance product offered by any insurer. This list of plans listed here comprise of insurance products offered by all the insurance partners of Policybazaar. For a complete list of insurers in India refer to the Insurance Regulatory and Development Authority of India website, www.irdai.gov.in *All savings are provided by the insurer as per the IRDAI approved insurance
plan.
^The tax benefits under Section 80C allow a deduction of up to ₹1.5 lakhs from the taxable income per year and 10(10D) tax benefits are for investments made up to ₹2.5 Lakhs/ year for policies bought after 1 Feb 2021. Tax benefits and savings are subject to changes in tax laws.
+Returns Since Inception of LIC Growth Fund
¶Long-term capital gains (LTCG) tax (12.5%) is exempted on annual premiums up to 2.5 lacs. ++Source - Google Review Rating available on:- http://bit.ly/3J20bXZ
^^The information relating to mutual funds presented in this article is for educational purpose only and is not meant for sale. Investment is subject to market risks and the risk is borne by the investor. Please consult your financial advisor before planning your investments.
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