All the contributions you make to your 401(k) are on a pre-tax basis. By deferring money to your 401(k) before taxes, you not only avoid paying taxes now, but you reduce the amount of taxable income that Uncle Sam can take. You will have to pay federal and state income taxes when you withdraw from your 401k, but there’s always a chance you’ll retire in Florida, or another state which doesn’t have a state income tax. According to the IRS, those states, besides Florida, include: Alaska, Nevada, New Hampshire, South Dakota,Tennessee, Texas, Washington and Wyoming.
Another added benefit of an employer-matched 401(k) (besides the free money!) is that the money is available in case of an emergency withdrawal. In some cases, you may be able to borrow money from your 401(k), penalty free. However, if you quit your job or are laid off, before paying back the loan, you may be required to pay the full amount at termination. Always check with your financial professional before borrowing any money from your plan.
Keeping your 401(k) prepared
Besides being prepared for retirement, you also want to be prepared with your individual 401(k) and the restrictions and limits placed on it. These limits and rules can apply to switching jobs, borrowing from your account, and the penalties that may be incurred if you withdraw early from the account. As soon as you enroll in a 401(k), you should receive a Summary Plan Description. Your employer should provide it to you. If not, ask for it. This will describe your retirement plan and the options available to you regarding withdrawals, rollovers, and collections. You want to share this document with your financial professional so the two of you can decide what options fit you best when planning for the future. Many companies have restrictions on what can and can’t be done with your retirement fund. As with most financial planning, a little education goes a long way, and knowing the details of your plan will help make future job transitions a bit smoother.
A Few Restrictions
No such thing as a free lunch, you say? Well, there are restrictions, and in the case of 401(k)s you can only contribute the lesser of $14,000 or 100% of your compensation for the year 2005. If you work multiple jobs and have more than one 401(k), you are still limited to $14,000 a year total. However, that number will increase to $15,000 in 2006. If you’re over 50 and you’re trying to catch up, the law allows you to defer an extra $4000 for the year 2005. There is also a limit to when you can withdraw from your account penalty free. You must wait until age 59 ½ until you withdraw from your 401(k). Withdrawals before age 59 ½ are subject to a 10% penalty.
401(k)s aren’t the only option for retirement, but they’re definitely one of the most attractive. In a lot of cases, they offer free money and are relatively easy to roll over when you change jobs. You also have the convenience of deferring taxes and paying less each year to the government. Social Security probably shouldn’t be relied upon, and personal savings don’t often give you the chance for free money, so it only makes sense to participate in your employer’s 401(k) to add to your retirement plan.
By sitting down with a financial professional, you can make sure you’re prepared for retirement with a 401(k) that fits your investment style and your stage in life. You can also make sure that your financial well-being is prepared for any changes of career or investment styles by working with someone closely to handle it all with ease. Who knows, with a small amount of effort working with your financial professional, your preparation might even make General Patton proud.
