Just the Basics: Here’s What You Need to Know About Your 401(k)

Everyone sort of knows a 401(k) is a common retirement plan. But what do you know beyond that?

A 401(k) is a plan your company might offer that everyone calls “free money.” But all you see is a chunk of cash disappearing from every paycheck.

You hear “free money” thrown around because it’s common for employers to offer a 401(k) match. Whatever you contribute, they’ll throw in the same amount, to a set percentage of your paycheck.

What’s an Average 401(k) Match?

There’s no hard rule, but the most common 401(k) match is 50 cents on the dollar up to the first 6% you contribute — or 3%.

(Here’s where we plug The Penny Hoarder, which matches up to 4%. We’re hiring!)

So, let’s say you earn $52,000 a year, and your employer matches up to 3%. You’ll get $1,560 a year extra toward retirement.

Big deal. You can’t live on $1,500 a year or even $3,000 a year in retirement, so why bother?

401(k) Basics: How Does the Investment Work?

Here’s the other reason they call it “free money.”

Your 401(k) isn’t just savings; it’s an investment. The firm that sponsors your company’s 401(k) invests the money in index or mutual funds. (We’ll save those details for another day.)

Then, through what the mathematically challenged like to call the “magic” of compound interest, that money grows. A lot.

If you invest $25 a week — or $1,300 a year — starting when you’re 21, for example, a typical return of 7% would give you more than $25,000 a year to live on in retirement. If your employer matches your investment, you only have to give up $12.50 a week.

Still confused? Don’t worry. Here are all the details about how much little you need to save to retire rich.

You can handle that, right, Penny Hoarders?

Your Turn: Do you contribute to a workplace 401(k)?

Dana Sitar (@danasitar) is a senior writer at The Penny Hoarder. She’s written for Huffington Post, Entrepreneur.com, Writer’s Digest and more, attempting humor wherever it’s allowed (and sometimes where it’s not).