 Have
you heard about 401K retirement plans? Are you working in a company
that offers such kind of saving plan? Or have you been encouraged by
your co-employees to join in your company's 401K retirement plan?
Well, the 401K plan is not in fact a new concept.
It has been in existence for more than a decade now and many have
already considered it as one of the most efficient ways of investing
and saving money for retirement.
It is nice to know that the 401K plan was first
designed and considered to decide those who are familiar with the time
value of money. The time value of money is in fact a concept that
involves the proper handling of money in a way to save money for the
future. It is simply like having a $1 in your hand now and having $1
tomorrow, in which case the $1 you have in hand right now matters more
than the $1 that you may get a year from now. Get the idea? Well,
that's essentially is the principle of the time value of money, and the
401K retirement plan is to some degree designed with such principle in
mind.
So the 401K retirement plan is essentially
designed for those who have realized that every dollar you may get, in
spite of how big or small it is, matters most and may help support you
in the future if you consider compounding them over long periods of
time. As expected, they can result in thousands or even millions or
billions of dollars. That means additional wealth to your part.
It is for such fact in fact that many of the
companies these days have considered tax-advanced accounts and
investments that their employees may wish to participate. The usual
target of these accounts and investments are in fact those who are
thinking of retiring from work knowing the fact that every man and
woman who wishes to leave the work force someday needs to have an
income that can suitably support their living after the retirement.
Fortunately, in today's highly competitive and demanding world, saving
plans like the 401K were introduced and highly valued.
But what really is 401K plan retirement? What is
involved in the plan? How does it work? Are there any limits attached
to it? What are its advantages and disadvantages?
Well, let's take it slowly. After all, that's the best way to learn.
What is 401K Retirement Plan?
Established by the US tax code, the 401K
retirement plan is in the first place a retirement savings plan that is
funded by the contributions of the employee and the matching
contributions of the employer in a particular company. The main
highlight of this plan is in fact the contributions that are taken from
the pre-tax salary of the employers and the employees. The contribution
then became a fund which grows tax-free until withdrawn by those who
may be thinking about retirement.
The 401K retirement plan takes its name from one
of the sections of the Internal Revenue Code of 1978. Now, can you
guess the section? It's simply none other than section 401(k) which
covers the availability of an optional "cash or deferred" technique of
obtaining contributions from the employees. The 401K plan is a plan
qualified under the Section 401(a), which defines qualified plan trusts
in general, including the number of rules required for qualifications.
In this sense, it is maintained that every 401K plan is already a 401a
plan.
How Does the 401K Plan Work?
The 401K retirement plan works in a pretty simple
manner. If you find that your company offers it, what is left to you in
fact is the decision to select from the available funds that you want
to invest. The funds are often included in the 401K plan, so all you
need to do is to figure out which of the funds you want most. This is
also in line with deciding how much you want to invest in the fund. The
percentage is considered mainly. And, once you invest from the fund
given to you, your contribution will automatically be deducted from
your pay check prior to the taxes.
Any employee can contribute up to a percentage of
their pay into the plan according to the rules that govern the 401K
retirement plan. There are some instances also when employers will
match a percentage of your contributions, and once determined the
contributions you've placed along with any of the match contributions
from the employers are then invested into the funds of your choice.
What is now nice to know about the 401K is that
once your contributions and the match contributions of your employees
are invested into the fund, the fund will tend to grow without being
taxed. Aside from that, the funds can be withdrawn when you reach the
age of 59 and 1/2. However, it is significant to note that at this time,
you are entitled by the law to pay the income tax on the withdrawn
funds.
Is the age allowed for the withdrawal of the
funds matters most to the 401K? However, there are some possible ways
of withdrawals of the funds from the 401K before reaching the age of 59
1/2. The downside of these ways, however, is that they typically
require
certain kinds of penalty along with the payment of taxes.
The 401K plan also works in two different ways,
either by a defined benefit or a defined contribution. With the former
technique, the employer is entitled to promise to pay a defined amount
to those who are thinking about retiring. However, there is a limit to
this promise. The employers are only entitled to pay a defined amount
to the retirees who have met particular criteria of eligibility. Those
who have no proof of eligibility can't benefit from it.
To put it simple words, the defined benefit is a
plan that associates the benefit to the amount of service spent by the
employee. It is also based on the final average salary, and it is due
to this rule that employees have the capability to predict the monthly
retirement income that they might receive with this kind of 401K plan.
They might also be given the chance to consider and use a lump sum
advantage in case they decided to leave from the work force.
Conversely, with the defined contribution plan,
the 401K defines the contributions that an employer can make. This does
not include the advantage that the employee will reap at the period of
his or her retirement. It is somehow clear that the defined
contribution plan covered by the 401K is not a defined benefit, leaving
the employee incapable of predicting a monthly retirement income. So it
follows that when the employee decided to leave the company, he or she
will receive the proceeds in a current or deferred annuity.
Well, note that there is one possible consequence
that may occur along with your plan. That's essentially the time when
your company gets bankrupt. If this will happen, chances are you won't
get the money you've invested into your company's fund. The reason?
Once your company gets bankrupt, you may likely lose the fund.
In line with the issue on bankruptcy, there are
some instances when your 401K balance may decline. The question now is
what you can do to solve this problem?
A decline in 401K balance is not a new thing. It
typically happens in this kind of saving plan. But there's something
you can do to repair your balance, that is, to look closely at how you
are investing. Yes, what matters most is your way of investing. So if
you find yourself investing too much that you've surpassed the level of
amount that your employer is putting to the fund, it's now time to
reduce your investment. Lessen and diversify it. This also means
adjusting your contributions so to make the most of the limits of the
new contributions set.
However, it is worth noting that your age and the
plan policy that your company has maintained can be two of the deciding
factors in your strategy in repairing your declining 401K balance. It
follows then that as you age, the duration to rebuild your retirement
plan can be shorter than those who are younger than you.
Reasons to Apply for 401K Retirement Plan
So the basics of the 401K retirement plan are
given. Now let's consider the reasons that more and more people are
considering it. Later in this page, we will consider the advantages and
disadvantages of the plan. But now, let's focus much on the reasons.
Here are the following:
Reason #1: Saving and Investing in the 401K Plan is So Easy
As you may have been told, once you have placed
your contributions to the 401K plan that your company offered to you,
the tendency is your contributions will automatically be deducted from
your paycheck. This for sure permits you to save regularly and not miss
the money.
Aside from that, in 401K retirement plan, your
money is invested in funds of your choice. This is but part of the
rule. In this case, the options for investment are typically
pre-screened and this is what guarantees you to get an investment that
has a reduced level of possible risks. This is of course is a good
news.
Reason #2: Contributions in 401K are Made Prior to the Reduction of Taxes
You are not left with the responsibility to pay
the taxes on your contributions until you decided to withdraw the money
in the 401K retirement plan. In this case, you certainly have the
chance to invest more. You can even consider yourself in the lower tax
bracket if you wish.
Now, isn't it a good idea?
Reason #3: The Earnings Are Not Taxed Without Ado
The explanation for this third reason of opening
a 401K retirement plan is somehow similar to that mentioned in the
second reason - you have no responsibility for the income tax on your
investment earning until the money is withdrawn.
So if that is the case, you are left with the
chance to set yourself in a lower tax bracket particularly when you are
qualified to take the money from your plan. This simply means more
savings on taxes.
Reason #4: You have the Right to Choose How Much You Can Contribute
In the 401K retirement plan, every participant is
entitled with a right to decide on the amount they want to contribute
in the fund. So this means that you can select how much you want to
place or add in the fund. This of course must be in line with how much
you can afford to your 401K plan. But, still there is a limit to the
amount. The rule of the thumb is place an amount up to the maximum
allowed by the government. Note that the maximum amount allowed by the
government is scheduled to increase year after year. So watch out for
the changes in the contribution limit.
Reason #5: You Can Own Both Your Account and Your Employer's Match Contributions
Well, this is the fifth and the last common
reason for opening the 401K retirement plan. This reason is simply
patterned from the fact that every participant of the 401K retirement
plan has the chance to own his or her accounts along with the match
contributions placed by the employer. The good news is that most of the
employers match about 50 percent of an employee's contribution to the
plan. This matching, nevertheless, may contain a particular limit on
the percentage that the employee will match. For instance, you might be
able to add about 10% of your earnings to your 401K plan. From that
percentage, you employer may match the whole 10% or a lesser percentage
to your fund. That fund will grow and you are entitled to withdraw the
total fund, including the match contributions of your employer.
Additionally, if the idea of changing jobs occurs
to you, the money you placed in your 401K retirement plan can be rolled
over to your new employer or through an IRA, which is but another
retirement program. So if you think that changing jobs may ruin your
established 401K plan, it's now time for you to change such perception.
There is always a chance for you to make your future well-planned and
401K plan is one good choice.
A Few Disadvantages of the 401K Plan
Everything about the nature and advantages of the
401K retirement plan has been said. It's now time for you to consider
some disadvantages known to this retirement plan.
First it is significant to know that the 401K
plan can't be accessed easily until you reached the age of 59 1/2. This
fact is mentioned earlier, and there are some ways to withdraw the fund
earlier than this age, but particular penalties along with the income
tax are attached to it.
Second, the 401K plans typically don't have the
luxury of being insured by the Pension Benefit Guaranty Corporation
(PBGC), but in other case, some pension plans available today don't
enjoy this kind luxury either.
The third and last disadvantage is that there is
lesser chance for you to own the matching contributions placed by your
employer as it is usual in the plan that the matching contributions are
not vested until a number of years have passed. According to some
resources, one rule in the 401K plan holds that the matching
contributions must vest according to either a three-year "cliff" plan,
or a 6-year "graded" plan. If your company has offered 401K, the
management knows this for sure.
The 401K retirement plan, although it comes with
certain disadvantages, remains until now as a significant part of
retirement planning. With this, it is expected that those who may want
to retire from work someday should learn and understand everything that
they possibly can about the plan. Perhaps the most brilliant move you
can take now is to gather information on everything that is related to
the concept, such as vesting, contribution limits and matching funds.
Once learned, keep track of your investments regularly and don't be
afraid to ask for assistance. That's simply it!
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