401k Retirement Plans

Overview
 

The 401k is a very popular retirement savings account in the US. The 401k retirement plans are in vogue in the country since 1980s. It was the first widely accepted retirement plans for the employees in America. Since its inception, it has been well serving the needs of the US employees as a popular alternative to traditional retirement plans.

This is funded by the contributions from the employee as well often matching contributions from the employers. The major allurement to this plan is that contributions to this scheme are made from pre-tax salary and the funds develop tax-free until they are withdrawn. In addition to this, these schemes are self-directed and transferable.

Both for profit and many types of tax-exempt organizations can establish these plans for their employees. Contributions made by the employers can vary. As per the records in 2011, around 60% of the US households nearing the retirement age have 401k type accounts.

 

Different 401k Retirement Plans

The rules and regulations governing the 401k retirement plans are enshrined in IRS Section 401k. Depending upon the structure of the scheme, the assets in the 401k grow tax-deferred or tax free. Apart from the tax structure, the 401k schemes may have different asset management structures. Below here we provide you descriptions about different 401k retirement plans.

 

Tax-Deferred 401k

 

This is a traditional kind of 401k program. This is set up by the employers and they pay the administrative costs for the employees to create the retirement investment account for the employees. The employers work in unison with the plan administrators to offer a large variety of investment options to meet the diverse objectives of the workers. The contributions made by the employees are directly taken from their monthly salary and these are pre-tax funds. Assets are accumulated with no annual tax consequences. However, when the funds are distributed after the age of 59.5 year, the distribution amounts are treated as ordinary income and taxed accordingly.

 

Roth 401k
The contributions made by the employees are treated in the same way as that of the traditional tax-deferred plan. Matching contributions are made by the employers also. The employer cost basis is maintained by the administrator with the employee for taxes on this amount when distributions areThis was created under the provision of the Economic Growth and Tax Relief Reconciliation Act of 2006. made. This must be held for at least five years to qualify for tax-free withdrawals.


Investment Choices

 

The structure of the 401k scheme is controlled by IRS regulations. However, the employers, in conjunction with the plan administrator, design the investment options. Majority of the 401k plans, irrespective of whether they are tax-free or tax-deferred, offer a selection of mutual funds. Investment selections may range from investing in aggressive small cap or international funds, money markets and conservative bond funds. Other investment avenues where the funds are invested include company stock and annuities. Majority of the publicly traded companies will offer company stock to the employees through the 401k plan.

 

Advantages of 401k Retirement Plans

 

The 401k retirement plans are hugely beneficial to the employees. The most outstanding benefit of this plan is that the employers match the contributions of the employee to a certain point. This matching however depends upon the financial ability and the discretion of the employers. The matching contribution should be around 25%, 50% or 100% of the contribution made by the employee. This implies that each time an employee contributes, the employer also adds money. This enhances the chance for the workers to retire in style and in a peaceful mind. Apart from this, there are other distinct benefits of this scheme, which are listed below.


- All the monetary contributions are made on a pre-tax basis. You can defer money to your 401k before taxes. In this way you can not only avoid paying taxes now but also you can reduce the amount of taxable income that the government can take.
- At the time of withdrawal money from the account, you will have to pay state as well as federal income taxes. But, there are some states in the United States, such as the Florida which do not impose state income tax. If you relocate to such state, you can save a lot of money.

 

-Money can be withdrawn from the account in case of emergency. But, if you have not reached 59.5 years, a penalty of 10% would be charged to withdraw money from the account.

 

-You are allowed to borrow money from the account without any penalty. In case you being laid off or leaving the job prematurely, you are supposed to pay the full amount at termination. It is recommended to think twice before taking loans from 401k account.

 

- Once you have crossed the age of 50 years, you can make some more contributions to your account. This additional ‘catch up’ contributions made by you would surely boost your savings. This will make your future years more prosperous.

 

-Any type of gains from investment or from dividends are tax-deferred. This may result in to years of tax deferred growth. This may exert a positive impact on your retirement funds.

 

- One important feature of this scheme is the inherent flexibility associated with it. Depending upon your will, you can increase, decrease or entirely stop the contributions made by you. In case of switching to other job, you can either transfer it to your new employer’s 401k or rollover your existing 401k saving into an Individual Retirement Account.

 

How safe is your money?

The 401k plan is well secured by the Employment Retirement Income Security Act (ERISA). The regulations of ERISA are aimed at protecting the retirement income of the individuals. The 401k deposits are held in custodial accounts to ensure the safety of the investment made by you. The employers have to mandatorily send the statement of the account to the employee at a regular basis and provide detailed information and all the updates about investment opportunities within your plan. Employers contribute matching amount as that of the employees. There is an important aspect in this scheme which is called the ‘vesting schedule’. Under this rule, if the employer has a 3 year vesting schedule, it increases the ownership of the money by one third every year.