Posted on: 22nd Jun, 2005 04:03 am
One of the smart ways to save and invest for your retirement is the employer-sponsored 401(k) Retirement Plan. This article explains the basics of the plan and highlights the following aspects:
This retirement plan helps you to authorize your employer to deduct a certain amount of money from your salary before taxes are calculated and put it in the retirement account. You may also utilize the cash in the account for investment purposes.
- What is 401(k) Plan?
- How does the plan work?
- How do you benefit from the plan?
- What are its drawbacks?
- Can you take a loan from your 401(k) account?
- How can you improve your declining 401(k) balance?
What is 401(k) Plan?
This retirement plan helps you to authorize your employer to deduct a certain amount of money from your salary before taxes are calculated and put it in the retirement account. You may also utilize the cash in the account for investment purposes.
How does the plan work?
- Maximum Contribution:
When you participate in a 401(k) plan, you tell your employer how much you want to pay for your retirement account. You can usually put up to 15% of your salary into the account each month, but the employer has the right to limit that amount. The IRS limits your total annual contribution to $ 15,500 (for 2008). - Employer's Contribution:
Your employer's contribution may match yours but at different levels. A typical match might be 25%-50% of your own contribution up to a certain level. - Investment Options:
With the new rule coming into effect from the end of October 2007, employers can select from a list of pre-approved funds which they consider suitable for long-term investments. Actively managed funds, life-cycle and balanced funds will be accepted but money market and stable value funds will be excluded from the investment list. - Withdrawal Option:
After reaching 59 and 1/2 years you may withdraw from your retirement account without paying the penalty. But after 70 and 1/2 years you must withdraw a required amount, that is the minimum distribution. Otherwise, you will have to pay an accumulation tax as much as 50% of your required distribution. - Added Contribution:
A Catch-Up Contribution option has been added to this retirement plan. This option enables participants aged 50 and above to increase their contribution in the retirement account. It refers to a supplementary pre-tax contribution made by the participant in excess of the IRS limit or even an employer-imposed plan limit. The annual catch-up contribution limit is $5000 for 2008.
Eligibility for catch-up contribution:-
- Participant has to be in pay status.
- They are not in the 6 months non-contribution period following the receipt of financial hardship in-service withdrawal.
- The participant's regular plan contributions must reach at least one of the following limits to qualify for catch-up contribution:
- The Annual Deferral Limit ($15,500 for 2008).
- The Plan's Deferral Limit (up to 15%).
How do you benefit from the plan?
The benefits that you share from the 401(k) plan are as follows:-
- The money you contribute comes out of your paycheck before taxes are calculated and this means that by contributing to a 401(k), you can actually lower the amount you pay each time in current income taxes.
- All employer contribution and any growth in the 401(k) account grow tax-free till you withdraw it. Once you start withdrawing the required minimum distribution, you have to pay tax on the withdrawal at your current income tax rate.
- If your employer's contribution matches yours, the matched amount is your extra gain.
- The employee can decide where to invest current savings and/or future contributions so that he can get can get maximum returns on his investment.
- Unlike a pension plan, all contributions can be moved from one company's plan to another company's plan or to an IRA if the participant changes his job.
- The plan is protected by Pension (ERISA) laws.
What are its drawbacks?
Putting down your money into a 401(k) account is indeed advantageous but there are some drawbacks as given below:-
- It is difficult to access your 401(k) savings before the age of 59 and 1/2 years but it is not impossible. In case of emergency you can withdraw from your account before you reach this age but 10% of your total distribution will be charged as penalty along with the taxes.
- 401(k) plan is not insured by the Pension Benefit Guaranty Corporation.
- Employer matching contributions do not become the property of the employee until a number of years have passed.
Can you take a loan from your 401(k) account?
It is easier to take a loan from this account as you don't have to undergo a credit check or a lengthy approval process. Even the rate of interest is comparatively low and you pay the interest to yourself.
However, there are demerits too. The money out of the account is not growing, there may be fees involved in the process and the loan must be paid back immediately if you change your job. Moreover any default in loan repayment is considered as an early withdrawal forcing you to pay taxes and penalties.
However, there are demerits too. The money out of the account is not growing, there may be fees involved in the process and the loan must be paid back immediately if you change your job. Moreover any default in loan repayment is considered as an early withdrawal forcing you to pay taxes and penalties.
How can you improve your declining 401(k) balance?
Look closely at how you are investing. Then follow the simple steps given below:-
401(k) is an excellent way to plan for your retirement. It helps you to increase your savings and at the same time make money by investing in the plan options. Thus, you can have complete financial security at the time of your retirement with the help of 401(k) Plan.
- If you are investing heavily in your employer's company stock, reduce this amount and spread your investments.
- Adjust your contributions and you can contribute the maximum tax-deferred amount to your 401(k) account.
401(k) is an excellent way to plan for your retirement. It helps you to increase your savings and at the same time make money by investing in the plan options. Thus, you can have complete financial security at the time of your retirement with the help of 401(k) Plan.
OUR COMPANY WOULD LIKE TO SETUP A 401 K PLAN FOR OUR EMPLOYEES. WE ARE A SMALL COMPANY OF 11 EMPLOYEES. IF YOU CAN HELP US PLEASE CONTACT ME AT 760 324-9333
Hi,
I shall forward your request to our Site Administrator and let you know what can be done in this regard.
Thanks,
Caron.
I shall forward your request to our Site Administrator and let you know what can be done in this regard.
Thanks,
Caron.
Can I make weekly/monthly cash contributions to my 401K after I have quit my job? Can I do this after I have rolled into the IRA?
Hello Rhsalot,
When you quit your job, you should rollover the 401k account either to your new employer's 401k program or to the IRA and then you may keep on making contributions to that.
When you quit your job, you should rollover the 401k account either to your new employer's 401k program or to the IRA and then you may keep on making contributions to that.
thanks jenkin, I own my own business, i will be working there full time. Right now we are not set up for a 401K. Just wondering if i could make cash contributions to the rolled over IRA.
Hello Rhsalot,
Yes, you can always do that.
Yes, you can always do that.
Thanks Jenkin, What other options are there if I do not want the IRA?
Hello Rhsalot,
I think IRA is the best option to reduce the expenses.
I think IRA is the best option to reduce the expenses.
The company for which my husband used to work was shut off and all his 401k was in the company stock. It had contributions from his employer as well as his own contributions. His financial advisor suggested him to withdraw the entire amount and rollover to an IRA. He was advised to invest after that was done. But unfortunately, when we went to pay our taxes we were told that we have to pay the penalty as well as taxes on the entire amount withdrawn from the 401k. Do we really owe the penalty and taxes? Please help
Hello Dorothy,
Was it a direct rollover from the 401k account to the bank or did they issue a check to your husband which he later put in the bank IRA accounts?
If it was a direct rollover then you don't have to pay taxes and penalty for that. There might have been some mistake in the code in box 7 of your 1099-R form. Consult your tax accountant and ask him to thoroughly go through the 1099-R form.
If your husband was issued a check from the 401k account which he later deposited in the bank IRA, then you may have to pay penalties and taxes. You had 60 days from the date the check was issued within which the proceeds should have been rolled over to the IRA. If this was not done, then you have to pay an early withdrawal penalty and will be added to your taxable income.
Feel free to ask the community if there's any further query.
Was it a direct rollover from the 401k account to the bank or did they issue a check to your husband which he later put in the bank IRA accounts?
If it was a direct rollover then you don't have to pay taxes and penalty for that. There might have been some mistake in the code in box 7 of your 1099-R form. Consult your tax accountant and ask him to thoroughly go through the 1099-R form.
If your husband was issued a check from the 401k account which he later deposited in the bank IRA, then you may have to pay penalties and taxes. You had 60 days from the date the check was issued within which the proceeds should have been rolled over to the IRA. If this was not done, then you have to pay an early withdrawal penalty and will be added to your taxable income.
Feel free to ask the community if there's any further query.
Hello dorothy, what is this 1099-R form and how much of withdrawal penalty is required to be paid?
Hello Swift,
I think I can help you with the first part of your query.
An IRS 1099-R form is used by individuals to report his/her distributions from annuities, retirement plans, IRAs, insurance or pension. The form includes information like the gross distribution paid during a particular year, the amount of the distribution that is taxable, any withheld Federal income tax, contributions made to an investment or premiums paid as well as a code to identify the type of distribution made to the individual.
I think I can help you with the first part of your query.
An IRS 1099-R form is used by individuals to report his/her distributions from annuities, retirement plans, IRAs, insurance or pension. The form includes information like the gross distribution paid during a particular year, the amount of the distribution that is taxable, any withheld Federal income tax, contributions made to an investment or premiums paid as well as a code to identify the type of distribution made to the individual.
I'm am 59 1/2. Can I pull a large portion out and put into Mutual Funds. I'm still employeed with the company and would like to continue putting into my 401K but would also like to take this large portion and put into the Mutual funds.
Hi Becky,
As much as I understand, you can invest money taken out from 401k plan account into mutual funds. Since you are 59 and 1/2 years of age, you need not pay penalty for the withdrawal. The 3 major types of mutual funds you may go for are Money market funds, Bond mutual funds and Stock mutual funds .
Good luck
As much as I understand, you can invest money taken out from 401k plan account into mutual funds. Since you are 59 and 1/2 years of age, you need not pay penalty for the withdrawal. The 3 major types of mutual funds you may go for are Money market funds, Bond mutual funds and Stock mutual funds .
Good luck
what is 72(t) ?