There are two types of pension plans:
1. Defined Benefit Plan (or) qualified benefit plan
2. Defined Contribution Plan (or) non-qualified benefit plan
Defined Benefit Plan :An employer-sponsored retirement plan where employee benefits are sorted out based on a formula using factors such as salary history and duration of employment. Investment risk and portfolio management are entirely under the control of the company. There are also restrictions on when and how you can withdraw these funds without penalties.
This fund is different from many pension funds where payouts are somewhat dependent on the return of the invested funds. Therefore, employers will need to dip into the companies earnings in the event that the returns from the investments devoted to funding the employee's retirement result in a funding shortfall. The payouts made to retiring employees participating in defined-benefit plans are determined by more personalized factors, like length of employment.
A tax-qualified benefit plan, shares the same characteristics of a defined-benefit plan, but also provides the beneficiary of the plan with added tax incentives. These tax incentives are not realized under non-qualified plans.
Defined Contribution Plan :A retirement plan in which a certain amount or percentage of money is set aside each year by a company for the benefit of the employee. There are restrictions as to when and how you can withdraw these funds without penalties. But,There is no way to know how much the plan will ultimately give the employee upon retiring. The amount contributed is fixed, but the benefit is not.
Showing posts with label Retirement Plans. Show all posts
Showing posts with label Retirement Plans. Show all posts
Wednesday, December 3, 2008
Required Minimum Distribution
What is Required Minimum Distribution?
The Required minimum distribution method is a simple way of calculating substantially equal periodic payments and is one that resets every year. It is basically calculated by dividing your retirement account balance by your life expectancy factor as provided by the IRS grid.
You will have three choices for a life expectancy factor. You can either go with single life expectancy(no beneficiary), joint life expectancy, or the Uniform Lifetime table. The latter two assume a beneficiary. Remember, the longer you expect to have to pay benefits, the
How do I calculate the payment?
First you need to determine what your account balance is. The IRS does not provide guidelines on this except by saying that the balance must be determined in a reasonable manner. The most prudent thing to do here would be to use the balance of your account from the end of the prior tax year.
Now that you have your balance, you will divide this by the life expectancy factor that you derived from one of the three life expectancy tables we mentioned above. This is the amount you will receive in the first year.
This process must be repeated every year and be sure to only distribute the exact amount that you calculated.
Advantages of using Required Minimum Distributions Methodology
Being that you will be receiving an adjusted amount every year, this method allows you to actually withdraw an amount which takes into account your gains/losses from the prior year.
Disadvantages of using Required Minimum Distributions Methodology
The drawback to using this method is probably obvious to you now. Your distributions could swing drastically up and down as your investments fluctuate. If you are looking for stable payments every year, this may not be the best option. The nature of the life expectancy table renders smaller payments upfront and larger payments as you approach retirement. This could be troubling for some of you as well.
It is a big step to decide which form of computation you will be using to determing periodic payments; it is advisable to seek the help of a professional before you make the final move.
Miscellaneous Rules
Just a few other rules to know about when it comes to required minimum distributions.
* Instead of taking a yearly distribution, it is acceptable to take more regular withdrawals, such as monthly or quarterly as long as long as the distributions meet the required amount.
* If you have multiple IRA's in which you wish to take money from, you essentially are allowed to withdraw more money. The IRS rule allows you to withdraw the total allowable aggegate amount from a single IRA. For example, assume you can take $10,000 from three different IRA's, for a total of $30,000. Essentially, you will be allowed to take $30,000 from a single IRA if you would prefer.
* Individuals who withdraw more than the required minimum distribution for the year cannot use the excess as a credit fro the following year. For example, if your required minimum distribution for last year was $2,000 and you withdrew $3,000; you must reduce your IRA balance from which you calculate RMD upon by $3,000.
The Required minimum distribution method is a simple way of calculating substantially equal periodic payments and is one that resets every year. It is basically calculated by dividing your retirement account balance by your life expectancy factor as provided by the IRS grid.
You will have three choices for a life expectancy factor. You can either go with single life expectancy(no beneficiary), joint life expectancy, or the Uniform Lifetime table. The latter two assume a beneficiary. Remember, the longer you expect to have to pay benefits, the
How do I calculate the payment?
First you need to determine what your account balance is. The IRS does not provide guidelines on this except by saying that the balance must be determined in a reasonable manner. The most prudent thing to do here would be to use the balance of your account from the end of the prior tax year.
Now that you have your balance, you will divide this by the life expectancy factor that you derived from one of the three life expectancy tables we mentioned above. This is the amount you will receive in the first year.
This process must be repeated every year and be sure to only distribute the exact amount that you calculated.
Advantages of using Required Minimum Distributions Methodology
Being that you will be receiving an adjusted amount every year, this method allows you to actually withdraw an amount which takes into account your gains/losses from the prior year.
Disadvantages of using Required Minimum Distributions Methodology
The drawback to using this method is probably obvious to you now. Your distributions could swing drastically up and down as your investments fluctuate. If you are looking for stable payments every year, this may not be the best option. The nature of the life expectancy table renders smaller payments upfront and larger payments as you approach retirement. This could be troubling for some of you as well.
It is a big step to decide which form of computation you will be using to determing periodic payments; it is advisable to seek the help of a professional before you make the final move.
Miscellaneous Rules
Just a few other rules to know about when it comes to required minimum distributions.
* Instead of taking a yearly distribution, it is acceptable to take more regular withdrawals, such as monthly or quarterly as long as long as the distributions meet the required amount.
* If you have multiple IRA's in which you wish to take money from, you essentially are allowed to withdraw more money. The IRS rule allows you to withdraw the total allowable aggegate amount from a single IRA. For example, assume you can take $10,000 from three different IRA's, for a total of $30,000. Essentially, you will be allowed to take $30,000 from a single IRA if you would prefer.
* Individuals who withdraw more than the required minimum distribution for the year cannot use the excess as a credit fro the following year. For example, if your required minimum distribution for last year was $2,000 and you withdrew $3,000; you must reduce your IRA balance from which you calculate RMD upon by $3,000.
72(t) Calculator: Early withdrawals from retirement accounts
72(t) distributions refer to Section 72(t) of the Internal Revenue Code, which deals with the 10% penalty tax on early distributions from retirement plans and IRAs. Generally, withdrawals from IRAs and retirement plans prior to attaining age 59 1/2 are subject to a 10% early withdrawal penalty tax. However, under Section 72(t) there are ways for you to avoid the 10% penalty, provided certain criteria are met. Use this calculator to determine your allowable 72(t) distribution and how it can help fund your early retirement or meet an immediate financial need.
articlesource:http://www.nylim.com/rcg/0,2058,70_1020084,00.html
for the calculation :http://www.nylim.com/rcg/0,2058,70_1020084,00.html
articlesource:http://www.nylim.com/rcg/0,2058,70_1020084,00.html
for the calculation :http://www.nylim.com/rcg/0,2058,70_1020084,00.html
Employee Stock Ownership Plans - ESOP
A qualified, defined contribution, employee benefit (ERISA) plan designed to invest primarily in the stock of the sponsoring employer. ESOPs are "qualified" in the sense that the ESOP's sponsoring company, the selling shareholder and participants receive various tax benefits. ESOPs are often used as a corporate finance strategy and are also used to align the interests of a company's employees with those of the company's shareholders.
Employee stock ownership plans can be used to keep plan participants focused on company performance and share price appreciation. By giving plan participants an interest in seeing that the company's stock performs well, these plans are believed to encourage participants to do what's best for shareholders, since the participants themselves are shareholders.
In short : An employee stock ownership plan, or ESOP for short, is a stock bonus plan that invests corporate profits back into the stock of sponsoring employer by rewarding employees with company stock. An ESOP is a qualified plan and therefore, provides special tax benefits
Employee stock ownership plans can be used to keep plan participants focused on company performance and share price appreciation. By giving plan participants an interest in seeing that the company's stock performs well, these plans are believed to encourage participants to do what's best for shareholders, since the participants themselves are shareholders.
In short : An employee stock ownership plan, or ESOP for short, is a stock bonus plan that invests corporate profits back into the stock of sponsoring employer by rewarding employees with company stock. An ESOP is a qualified plan and therefore, provides special tax benefits
Retirement Plans?
Retirement planning is a big concern for every one. You always pray for a smooth transition with family, friends and also, enough funds.
In the 1950s, Abraham Maslow put all this in form of a theory, popularly known as the "Hierarchy of needs". In brief, it basically addresses the issue of "survival to self-actualisation".
The first step in Maslow's ladder is "psychological needs" that dominate our lives. These include our basic needs of food, clothing, shelter and others. Once these basic needs are taken care of, we move to our next set of needs, called "safety needs." We need protection, stability and of course, a society which has proper law and order.
After that comes the need for belonging through family, friends and community. And then, there is the need for self-esteem, which comes through status, fame, dignity and ability to influence decision making in the family or community. All the above four needs called "deficits needs."
The last need is popularly known as the "need for self-actualisation." Seldom can one satisfy this last need. It is the endless drive to be all that we "can be" or "can achieve".
Similar to the working person, even the retirees follow the same hierarchy of needs. The first and basic retirement need is food, clothing and shelter. Retirees - like all of us - have the fear of survival. Will my wealth outlive me or will I outlive my wealth is the question that they ask themselves. This basic need can get satisfied with the creation of retirement corpus.
Once the basic need is satisfied, next is need for security and protection. Here we are not just referring to physical protection but also financial protection. Most retirees choose debt-based instruments, as they give security of principal (though it loses to inflation.) Pension system is one form of security for retirees.
The next is a system where they will be safe. With the growing instances of physical assault, thefts and murder on senior citizens on the rise, the issue has to be jointly being addressed by police, government, society and community.
Retirees seek love and warmth of family, friends and society. In the Indian society, elders are a part of the family. Beyond family members, today there are a large number of formal and informal community/activity centres where the retired can meet and spend time together. The sense of belonging is going to be addressed by such centres.
There is a serious requirement of specialised colonies that will cater exclusively to the needs of the elderly. These colonies will need to have several facilities like basic health care, round the clock security and recreational activities. Also, they have to address basic and safety needs.
However, as of now, Indian companies are not aggressively coming out with specialised products like accommodation and insurance for the retirees. This is primarily because we are still living in the world where it is assumed that the retired would not have corpuses to fund these products.
The next generation of retirees would definitely have better corpuses, encouraging companies to create specialised products for them. The retiree of today has more money power than what his parents or grand parents had.
They are very status conscious and seek a lifestyle. The ultimate need of self-actualisation can be addressed by giving back to society by using their skill set.
Retirement planning is not restricted to a mere number. It is more to do with satisfying the needs of the person. And since they are not all financial needs, one will need to understand that a great corpus is just not enough.
articlesource:reddif.com
In the 1950s, Abraham Maslow put all this in form of a theory, popularly known as the "Hierarchy of needs". In brief, it basically addresses the issue of "survival to self-actualisation".
The first step in Maslow's ladder is "psychological needs" that dominate our lives. These include our basic needs of food, clothing, shelter and others. Once these basic needs are taken care of, we move to our next set of needs, called "safety needs." We need protection, stability and of course, a society which has proper law and order.
After that comes the need for belonging through family, friends and community. And then, there is the need for self-esteem, which comes through status, fame, dignity and ability to influence decision making in the family or community. All the above four needs called "deficits needs."
The last need is popularly known as the "need for self-actualisation." Seldom can one satisfy this last need. It is the endless drive to be all that we "can be" or "can achieve".
Similar to the working person, even the retirees follow the same hierarchy of needs. The first and basic retirement need is food, clothing and shelter. Retirees - like all of us - have the fear of survival. Will my wealth outlive me or will I outlive my wealth is the question that they ask themselves. This basic need can get satisfied with the creation of retirement corpus.
Once the basic need is satisfied, next is need for security and protection. Here we are not just referring to physical protection but also financial protection. Most retirees choose debt-based instruments, as they give security of principal (though it loses to inflation.) Pension system is one form of security for retirees.
The next is a system where they will be safe. With the growing instances of physical assault, thefts and murder on senior citizens on the rise, the issue has to be jointly being addressed by police, government, society and community.
Retirees seek love and warmth of family, friends and society. In the Indian society, elders are a part of the family. Beyond family members, today there are a large number of formal and informal community/activity centres where the retired can meet and spend time together. The sense of belonging is going to be addressed by such centres.
There is a serious requirement of specialised colonies that will cater exclusively to the needs of the elderly. These colonies will need to have several facilities like basic health care, round the clock security and recreational activities. Also, they have to address basic and safety needs.
However, as of now, Indian companies are not aggressively coming out with specialised products like accommodation and insurance for the retirees. This is primarily because we are still living in the world where it is assumed that the retired would not have corpuses to fund these products.
The next generation of retirees would definitely have better corpuses, encouraging companies to create specialised products for them. The retiree of today has more money power than what his parents or grand parents had.
They are very status conscious and seek a lifestyle. The ultimate need of self-actualisation can be addressed by giving back to society by using their skill set.
Retirement planning is not restricted to a mere number. It is more to do with satisfying the needs of the person. And since they are not all financial needs, one will need to understand that a great corpus is just not enough.
articlesource:reddif.com
Monday, December 1, 2008
What are the benefits of 401k plan?
Benefits of a 401(k)
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.
Keeping your 401(k) prepared
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.
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.
What is 401k Retirement Plan?
401(k)s got their start back in 1978, when the IRS established a new provision to allow employees to
defer some of their compensation into an account with their employer. The beauty is that in many cases,
your employers will match your contributions to a certain point. Employer matches come in a wide variety
of options depending on the employer’s discretion. Some employers match contributions dollar for
dollar. Others match 25 or more cents on the dollar. That means each time you contribute, your employer
adds money, for free! Often times your employer will only match up to a certain percent of your salary. But
regardless, they’re adding to your retirement for you!
When you first enroll in a 401(k) plan, you’ll be given a list of investment options.
It’s best to sit down with a financial professional and figure out how you wish to
invest your money. Your options for investments will vary from conservative
fixed income investments to aggressive stock portfolios. You are able to
allocate your money into investments in different combinations depending on
how much growth you want to achieve, and how much risk you can tolerate.
articlesource:themoneyalert.com
defer some of their compensation into an account with their employer. The beauty is that in many cases,
your employers will match your contributions to a certain point. Employer matches come in a wide variety
of options depending on the employer’s discretion. Some employers match contributions dollar for
dollar. Others match 25 or more cents on the dollar. That means each time you contribute, your employer
adds money, for free! Often times your employer will only match up to a certain percent of your salary. But
regardless, they’re adding to your retirement for you!
When you first enroll in a 401(k) plan, you’ll be given a list of investment options.
It’s best to sit down with a financial professional and figure out how you wish to
invest your money. Your options for investments will vary from conservative
fixed income investments to aggressive stock portfolios. You are able to
allocate your money into investments in different combinations depending on
how much growth you want to achieve, and how much risk you can tolerate.
articlesource:themoneyalert.com
Retirement Plan- 401k
A 401k is a type of employer-sponsored retirement plan. It is a way for employees to save for their retirement by having a certain percentage of their paycheck withheld by their employer and deposited into the company's plan. Employers can choose to match the employee's contributions and thereby share the profits of the company with their employees. The plan is usually operated through an investment firm.
For example, Acme Company's 401k plan allows employees to contribute part of their paycheck into the plan. Acme will match incrementally up to 3% of the employees contribution. If the employee contributes 3%, Acme will contribute 2% to the employee's account. If the employee contributes 4%, the company will contribute 2.5%, and if the employee contributes 5% or more, the company will contribute 3%. The employer's contributions are called matching contributions.
As you can see, if an employer provides matching contributions, the employee can increase the amount of money he receives from his employer above and beyond his salary. For example, if Joe makes $30,000 in 2007 and contributes 5%, Acme will contribute an additional 3%. As a result, Joe will receive $30,000 plus $900 additional money from Acme's matching contributions. Joe's total compensation will be $30,900, not $30,000, simply because he participates in Acme's plan.
How does a 401k work?
Your employer withholds a certain amount of your paycheck and deposits that money, along with any matching contributions, into your 401k account. The money in the plan is invested in various financial instruments, such as mutual funds. The money stays in the account until you reach a certain age when it is legal to withdraw the money, or until you meet any of the several exceptions to the age rule. Since the money will be in the account over a period of years, this causes the account to earn money through compounding, so your account grows not only through your regular contributions made from your paycheck but also by earning interest or dividends.
How do I make contributions to a 401k?
You make a contributions through your employer. If you decide to participate in the plan, you will determine what percentage of your paycheck that you want to be deposited in your account, and your employer will withhold that amount from each paycheck you receive. The employer then deposits the withheld money into your account, along with any matching contributions, so contributions are made to your account each pay period.
Are there any limitations to making a contribution to a 401k?
Yes, there are limitations. You are limited by IRS rules and also by whatever rules your employer implements in his plan.
IRS Contribution Limitations
For 2007, the limit for contributions to defined contribution plans is the lesser of:
1. 100% of the participant's compensation, or
2. $45,000.1
Employer Limitations
When your employer sets up his plan, he can place limitations on contributions. The plan can be set up so that employees can only contribute up to a certain percentage of their paychecks. A common example is the limitation on matching contributions the employer will provide.
What is a company match?
A company match is when employers agree to contribute certain amounts to your 401k in addition to your own contributions. Employers may decide to make a contribution above and beyond what you decide to contribute. This is one version of what is commonly known as profit-sharing since the company gives you additional compensation toward your retirement. Because you are part of the company and your work helps contribute to any profit the company makes, employers use matching contributions as a way to reward employees for their input to the company's bottom line. This can also provide an incentive for employees to work harder in order for the company to make more money.
If my employer goes out of business before I retire and receive distributions from my 401k, what happens?
401k plans are covered by the Employee Retirement Income Security Act of 1974, or ERISA. Generally, if an employer goes out of business or becomes bankrupt, the employer's creditors receive the employer's assets to settle debts. However, ERISA protects your plan money from those creditors. The creditors generally cannot get any money from a 401k plan to settle debts of a bankrupt employer.2
When can I withdraw my money from a 401k?
You can withdraw your money at any time. However, if your withdrawal is an early distribution, you will have to pay an extra tax on the withdrawal.3
What is an early distribution?
An early distribution is any money taken out of your 401k before reaching age 59 ½. Early distributions are subject to a 10% tax penalty in addition to regular income taxes, so if you withdraw $5,000 when you are 45, you will have to pay $500 as a tax penalty. However, as discussed in the following question, there are some exceptions that allow you to withdraw money before age 59 ½ without owing the 10% penalty.4
Are there any other circumstances when I can withdraw my money before age 59 ½?
Yes, there are some exceptions to the age rule. You will not owe the 10% tax on an early withdrawal if the withdrawal is:
1. Made to a beneficiary after your death.
2. Made because the employee has a qualifying disability.
3. Made as part of a series of substantially equal periodic payments.
4. Made after separation from service if the separation occurred during or after the year when the employee reached age 55.
5. Made to an alternate payee under a qualified domestic relations order (QDRO).
6. Made to an employee for medical care.
7. Timely made to reduce excess contributions under a 401k plan.
8. Timely made to reduce excess employee or matching employer contributions (excess aggregate contributions).
9. Timely made to reduce excess elective deferrals.
10. Made because of an IRS levy on the plan.
11. Made a qualified reservist distribution.
How do you maintain a 401k?
You maintain your account by making contributions to it. You can only make contributions through your employer. The contributions are withheld from your paycheck, and any matching contributions from your employer are deposited into the plan by your employer.
If you leave the company, you can choose to leave your 401k as it is, or roll it over into a Traditional IRA.
If I quit my job where I was participating in a 401k plan, what happens?
The money you contributed to the 401k is always yours, regardless of how long you have worked for the employer. Generally, an employer requires that you work a certain number of years before you are vested, which simply means that you are legally entitled to the employer's matching contributions. Therefore, depending on your employer's rules, you may or may not be able to keep the employer's matching contributions.
There are several things that you can do with your account after leaving your job. One is to leave the 401k in your employer's plan until you decide what to do with it. You can even leave it there until you reach age 59 1/2 and can begin receiving distributions. However, your former employer may charge you fees for maintaining your 401k for you. Check the plan agreement for details about your former company's specific rules.
Another thing you can do is rollover your 401k into a Traditional IRA. Contributions to Traditional IRA's receive the same type of tax deferral treatment as contributions to 401k's, so you may be able to rollover your money into a Traditional IRA and not owe additional taxes.5
What if I am laid off or fired?
Your options include any of the solutions discussed in the previous question. Despite being fired or laid off, the contributions that you made to your account are still your money, so you are legally entitled to all contributions that you made. However, depending on the rules of your plan, you may not be entitled to the employer matching contributions.
Can I start a 401k if I already have an IRA?
Yes, you absolutely can participate if you also have IRA's, Traditional or Roth.
How does a 401k affect my federal income tax?
Contributions are considered "elective deferrals" of income, so you do not pay any federal income tax on them in the year you make the contribution. For example, John contributes $1,000 to his 401k in 2007, and his employer contributes $200. John's salary for the year is $30,000. He will pay federal income taxes on $29,000 only, which is his salary minus his $1,000 contribution.
However, Uncle Sam will never let you get away completely tax-free. When you take distributions from your plan during retirement, you will pay federal income taxes on that money then. For example, if Susan is age 65 and receives a $10,000 distribution in 2007, she will owe taxes on the $10,000. However, when she contributed to the plan years ago, she did not have to pay any taxes on the money she contributed then.6
Do I have to withdraw money at a certain age?
Yes, you must start withdrawing money by April 1 of the year after:
1. You reach age 70 ½, or
2. You retire from the company maintaining the 401k plan.7
What happens to my 401k after I die?
You may designate beneficiaries who will inherit your account after your death.8
Why participate in a 401k? Why not just invest that money in mutual funds?
By participating, you receive tax benefits that you would not receive by investing your money in mutual funds on your own. The money you contribute is not subject to income tax. Therefore, you end up paying fewer taxes by participating in the plan than if you bought mutual funds on your own. For example, Joe works for ABC Company. He makes $30,000 and contributed $1,500 to his 401k. He will owe federal income taxes on $28,500 only, not on his full salary of $30,000. He gets to deduct the contributions from his income before calculating his taxes.
Another reason to participate is that in most plans, employers match a portion of your contributions, so it is as if your employer is giving you free money simply by participating! For example, Joe of ABC Company makes $30,000 in 2007 and contributes $1,500 of that salary to his 401k plan in 2007. ABC Company provides matching contributions of $1000, so Joe really makes $31,000 in 2007, not just his $30,000 base salary.
articlesource:ezinearticles
For example, Acme Company's 401k plan allows employees to contribute part of their paycheck into the plan. Acme will match incrementally up to 3% of the employees contribution. If the employee contributes 3%, Acme will contribute 2% to the employee's account. If the employee contributes 4%, the company will contribute 2.5%, and if the employee contributes 5% or more, the company will contribute 3%. The employer's contributions are called matching contributions.
As you can see, if an employer provides matching contributions, the employee can increase the amount of money he receives from his employer above and beyond his salary. For example, if Joe makes $30,000 in 2007 and contributes 5%, Acme will contribute an additional 3%. As a result, Joe will receive $30,000 plus $900 additional money from Acme's matching contributions. Joe's total compensation will be $30,900, not $30,000, simply because he participates in Acme's plan.
How does a 401k work?
Your employer withholds a certain amount of your paycheck and deposits that money, along with any matching contributions, into your 401k account. The money in the plan is invested in various financial instruments, such as mutual funds. The money stays in the account until you reach a certain age when it is legal to withdraw the money, or until you meet any of the several exceptions to the age rule. Since the money will be in the account over a period of years, this causes the account to earn money through compounding, so your account grows not only through your regular contributions made from your paycheck but also by earning interest or dividends.
How do I make contributions to a 401k?
You make a contributions through your employer. If you decide to participate in the plan, you will determine what percentage of your paycheck that you want to be deposited in your account, and your employer will withhold that amount from each paycheck you receive. The employer then deposits the withheld money into your account, along with any matching contributions, so contributions are made to your account each pay period.
Are there any limitations to making a contribution to a 401k?
Yes, there are limitations. You are limited by IRS rules and also by whatever rules your employer implements in his plan.
IRS Contribution Limitations
For 2007, the limit for contributions to defined contribution plans is the lesser of:
1. 100% of the participant's compensation, or
2. $45,000.1
Employer Limitations
When your employer sets up his plan, he can place limitations on contributions. The plan can be set up so that employees can only contribute up to a certain percentage of their paychecks. A common example is the limitation on matching contributions the employer will provide.
What is a company match?
A company match is when employers agree to contribute certain amounts to your 401k in addition to your own contributions. Employers may decide to make a contribution above and beyond what you decide to contribute. This is one version of what is commonly known as profit-sharing since the company gives you additional compensation toward your retirement. Because you are part of the company and your work helps contribute to any profit the company makes, employers use matching contributions as a way to reward employees for their input to the company's bottom line. This can also provide an incentive for employees to work harder in order for the company to make more money.
If my employer goes out of business before I retire and receive distributions from my 401k, what happens?
401k plans are covered by the Employee Retirement Income Security Act of 1974, or ERISA. Generally, if an employer goes out of business or becomes bankrupt, the employer's creditors receive the employer's assets to settle debts. However, ERISA protects your plan money from those creditors. The creditors generally cannot get any money from a 401k plan to settle debts of a bankrupt employer.2
When can I withdraw my money from a 401k?
You can withdraw your money at any time. However, if your withdrawal is an early distribution, you will have to pay an extra tax on the withdrawal.3
What is an early distribution?
An early distribution is any money taken out of your 401k before reaching age 59 ½. Early distributions are subject to a 10% tax penalty in addition to regular income taxes, so if you withdraw $5,000 when you are 45, you will have to pay $500 as a tax penalty. However, as discussed in the following question, there are some exceptions that allow you to withdraw money before age 59 ½ without owing the 10% penalty.4
Are there any other circumstances when I can withdraw my money before age 59 ½?
Yes, there are some exceptions to the age rule. You will not owe the 10% tax on an early withdrawal if the withdrawal is:
1. Made to a beneficiary after your death.
2. Made because the employee has a qualifying disability.
3. Made as part of a series of substantially equal periodic payments.
4. Made after separation from service if the separation occurred during or after the year when the employee reached age 55.
5. Made to an alternate payee under a qualified domestic relations order (QDRO).
6. Made to an employee for medical care.
7. Timely made to reduce excess contributions under a 401k plan.
8. Timely made to reduce excess employee or matching employer contributions (excess aggregate contributions).
9. Timely made to reduce excess elective deferrals.
10. Made because of an IRS levy on the plan.
11. Made a qualified reservist distribution.
How do you maintain a 401k?
You maintain your account by making contributions to it. You can only make contributions through your employer. The contributions are withheld from your paycheck, and any matching contributions from your employer are deposited into the plan by your employer.
If you leave the company, you can choose to leave your 401k as it is, or roll it over into a Traditional IRA.
If I quit my job where I was participating in a 401k plan, what happens?
The money you contributed to the 401k is always yours, regardless of how long you have worked for the employer. Generally, an employer requires that you work a certain number of years before you are vested, which simply means that you are legally entitled to the employer's matching contributions. Therefore, depending on your employer's rules, you may or may not be able to keep the employer's matching contributions.
There are several things that you can do with your account after leaving your job. One is to leave the 401k in your employer's plan until you decide what to do with it. You can even leave it there until you reach age 59 1/2 and can begin receiving distributions. However, your former employer may charge you fees for maintaining your 401k for you. Check the plan agreement for details about your former company's specific rules.
Another thing you can do is rollover your 401k into a Traditional IRA. Contributions to Traditional IRA's receive the same type of tax deferral treatment as contributions to 401k's, so you may be able to rollover your money into a Traditional IRA and not owe additional taxes.5
What if I am laid off or fired?
Your options include any of the solutions discussed in the previous question. Despite being fired or laid off, the contributions that you made to your account are still your money, so you are legally entitled to all contributions that you made. However, depending on the rules of your plan, you may not be entitled to the employer matching contributions.
Can I start a 401k if I already have an IRA?
Yes, you absolutely can participate if you also have IRA's, Traditional or Roth.
How does a 401k affect my federal income tax?
Contributions are considered "elective deferrals" of income, so you do not pay any federal income tax on them in the year you make the contribution. For example, John contributes $1,000 to his 401k in 2007, and his employer contributes $200. John's salary for the year is $30,000. He will pay federal income taxes on $29,000 only, which is his salary minus his $1,000 contribution.
However, Uncle Sam will never let you get away completely tax-free. When you take distributions from your plan during retirement, you will pay federal income taxes on that money then. For example, if Susan is age 65 and receives a $10,000 distribution in 2007, she will owe taxes on the $10,000. However, when she contributed to the plan years ago, she did not have to pay any taxes on the money she contributed then.6
Do I have to withdraw money at a certain age?
Yes, you must start withdrawing money by April 1 of the year after:
1. You reach age 70 ½, or
2. You retire from the company maintaining the 401k plan.7
What happens to my 401k after I die?
You may designate beneficiaries who will inherit your account after your death.8
Why participate in a 401k? Why not just invest that money in mutual funds?
By participating, you receive tax benefits that you would not receive by investing your money in mutual funds on your own. The money you contribute is not subject to income tax. Therefore, you end up paying fewer taxes by participating in the plan than if you bought mutual funds on your own. For example, Joe works for ABC Company. He makes $30,000 and contributed $1,500 to his 401k. He will owe federal income taxes on $28,500 only, not on his full salary of $30,000. He gets to deduct the contributions from his income before calculating his taxes.
Another reason to participate is that in most plans, employers match a portion of your contributions, so it is as if your employer is giving you free money simply by participating! For example, Joe of ABC Company makes $30,000 in 2007 and contributes $1,500 of that salary to his 401k plan in 2007. ABC Company provides matching contributions of $1000, so Joe really makes $31,000 in 2007, not just his $30,000 base salary.
articlesource:ezinearticles
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