Archive for November, 2007
The 401K takes its name from the IRC (Internal Revenue Code) of 1978. The operation of the 401K is administered by the EBSA (Employee Benefits Security Administration) of the Department of Labor.
The 401K plan has a lot of advantages. First and foremost is that the employee can contribute pre-tax money that reduces the tax paid in each paycheck. Also, the company contribution and any growth in the fund is free of tax until withdrawn.
The compounding of the fund during a 20 to 30 year period is quite amazing. The employee has a lot of control in the direction of the future contributions. When the company matches your contributions, it adds something extra on top of your own money. All money in the plan can be moved from one company to another unlike pension.
The 401K plan is protected by pension laws since it is a personal investment plan. It includes protection from garnishment by creditors but not from domestic cases that include child support.
There are some disadvantages in the 401K plan, it is hard to get your 401K contributions before age 60 (59 1/2 to be exact). The 401K is not insured by the PBGC (Pension Benefit Guaranty Corp). Also, the company contributions do not kick in until a certain number of years of service have been given. The rules state that company matching contributions must either be a 3 year ‘cliff’ plan (100 percent after 3 years) or a 6-year ‘graded’ plan.
Employees participating in a 401K plan have many options for investment. In most cases a listing of mutual funds. The mutual funds usually include money market fund, treasuries, stock funds and bond funds. Some plans may include investing in company stock and US Savings Bonds. The employee gets to choose how the savings is invested. The employee can also choose at any time to stop contributions.
Financial advisers usually say that the average 401K contributor is non-aggressive in terms of their investment options. Stocks have historically outperformed other types of investment, since the 401K is a long term investment it should be able to minimize the stock fluctuations.
A 401K plan is a retirement savings plan that is funded by employee contributions and a matching contribution from the employer. Contributions are made from pre-tax salary and the funds grow tax-free until they are withdrawn. Companies, non-profit and other tax-exempt organizations can establish these plans for their employees. 401K retirement plans are named after the section of the Internal Revenue Code that prescribes the rules under which it operates. It is also known as cash or deferred arrangement (CODA) plan.
Under the 401K plans, an employer allows the employee to defer receipt of part of his or her compensation by contributing that part to his or her account. The Employee Benefits Security Administration of the U.S. Department of Labor regulates 401K plans.
Some 401K plans include a 50% matching contribution from the employer for the employee. Employers may also make contributions to an employee’s account independent of the employee’s contribution and these contributions may be tied to a firm’s profits as part of a profit sharing plan. Some 401K plans offer individuals an opportunity to direct accounts to a variety of investment options like mutual funds, stock market or company stock.
State governments are prohibited from offering 401K plans to their employees. Private, tax-exempt employers however, are eligible to establish a 401K plan for their qualified employees.
There are numerous advantages with 401K plans from the perspective of an employee. Employees can contribute to their 401K plan with pre-tax money. This reduces the amount of tax paid out of each salary check. All contributions from the employer and any growth of capital are exempted from taxes. The employee can decide where to direct future contributions and savings, giving them control over the investments. All contributions can be moved from one company’s plan to the next company’s plan if an employee changes jobs. 40 K plans are very popular as a retirement plan because of the double benefit of saving money for retirement as also saving on tax liability. plan.
An important aspect of investing is to always be aware of what amount you are allowed to contribute to your 401k account each year. 401k contribution limits change each year and there are two different 401k contribution limits you need to be aware of. The United States government sets the maximum limit allowable and your employer may also set their own 401k limits for their employees.
In the last couple of years, the U.S. Government has begun to understand the importance of saving for retirement and they realize that the 401k investment plan may be the best retirement vehicle for most wage earners in America. In recent years, the government has started to increase the limits to help individuals save for retirement. Realizing that social security may not be a viable option in the future, the government and companies are encouraging workers to save for their retirements by making 401k contributions.
Government Imposed 401k Contribution Limits versus Employer Imposed 401k Contribution Limits
The U.S. government puts out a list showcasing the maximum amount you can contribute to your 401k plan for that year. Employers may also set a maximum limit of what is allowed for their employees. For example, your employer might limit 401k contributions to a maximum limit of 10% of an employee’s salary. That means that an employee that earns $50,000 a year can effectively max their contribution out at $5,000. However an employee who earns $200,000 a year would not be eligible to max out at 10% ($20,000) because the 2007 401k contribution limit imposed by the government is $15,500.
Retirement investors should first consider what amount of 401k contributions is allowed by their employer and then compare that with the amount allowed by the U.S. government.
Catch-up Contributions
If you are 50 years of age or older, you may want to check with your employer to see if they offer “catch-up” contributions in your 401k plan. If they do, this will allow you to contribute up to the maximum your employer’s plan allows as long as this amount does not exceed the limits that have been imposed by the government.
Below are the maximum 401k contribution limits as well as the maximum Catch-up Contribution limits for 2006, 2007, and 2008.
2006 401k Contribution Limit: $15,000
2006 Catch-Up Contribution Limit (only for those over 50 years old): $5,000
2007 401k Contribution Limit: $15,500
2007 Catch-Up Contribution Limit (only for those over 50 years old): $5,000
2008 401k Contribution Limit: $16,000
2007 Catch-Up Contribution Limit (only for those over 50 years old): $5,000
When we start out work for the first time, we believe that we would stay with the same company until retirement and have a comfortable retirement life with all the money we have saved in our 401k account. Unfortunately this does not happen. In present day and time, we end up changing jobs several times before we reach retirement and this poses a lot of questions about what we should do with our 401k benefits.
When changing a job, you have a few choices with regard to your 401k account. You can either keep the 401k with your old employer, if they allow it, you can rollover your 401k account to your new employer, or you can rollover your 401k benefits to a self-directed IRA.
Keeping your 401k with your old employer will have no benefit for you or your employer, and most employers prefer that they ex-employees transfer the money. So, the next best option for you is to rollover the 401k benefits to your new employer.
Most 401k plans have just 15 mutual fund choices and you will benefit from rolling over your 401k to your new employer if your plan has a loan provision where it will be easy for you to borrow money.
You can also rollover over your 401k to a self-directed IRA and this is of two types — contributory and rollover IRA. In a contributory self-directed IRA, you can contribute annually but you can no longer roll back the 401k part to another new employer’s 401k. However, a rollover IRA is more flexible. A rollover IRA allows you roll back the proceeds to a 401k plan so that you can take advantage of the loan provision in the 401k plan. However, you should not make annual contributions to this IRA because of tax reasons. A rollover IRA is set up through a brokerage firm which means you will have access to the entire gamut of mutual funds that the firm has to offer.