All that you wanted to know about 401 (k) plans

401 (K) is a retirement plan which benefits many employees and therefore it’s essential to understand the basics of it

Planning for the retirement has always topped the priority list of the individuals. However, it seldom found that every individual starts early in life. In fact there are a lot of individuals who start late because of different reasons. For those who are the early starters things are different and they can always benefit of the early entry they make in the investments. However, for those who are the late beginners things are really not that tough given the current state of affairs where numerous investment tools can offer a better result in the same time period provided the  effort put in to maintain the accounts are increased a bit at prnewswire news about loans.

With the advanced medical facilities available one can easily see that the life expectancy of people is on the rise. Looking at this retirement planning too has to undergo changes. The number of years under the planning has to increase and so the amount which one requires at the end of the retirement period. While there are a number of retirement plans available in the market, one cannot discount the benefits associated with the 401 (k) plans.

Since 1978, 401 (k) plan has been the employer sponsored retirement plan which is most popular. Many workers use this service and hang on the money provided by them and numerous employers use the 401 (k) plans as a means to distribute the stock of the company to the employees. Recently, 401 (k) saw several variations such as SIMPLE 401 (K) and the safe harbor 401 (K). Here’s how 401 (k) plan helps billions of people for retirement plans.

About 401(k)

401 (k) is an arrangement which makes an employee either take compensation in cash or, under the plan, defer a percentage of it to an account. The amount is not taxable, to the employee, until the amount is not distributed or withdrawn from the plan. 401 (k) contribution can be made on an after-tax basis and the amount when withdrawn is without tax. 401 (k) plans are a sort of retirement plan called as a qualified plan. Defined-benefit plans or defined contribution plan are two types of qualified plans.

In 401 (k) plan the balance of a participant is determined by the performance of plan investment and contribution made to the plan and therefore it is a type of defined-contribution plan. The employer doesn’t need to make any offerings to the plan unlike the pension plan.

Limits of contribution:

Maximum amount that an employee can defer as compensation to 401 (k) plan, for 2013, is $17,500. Staffs with the age of 50 and senior can make extra contributions of up to $5,500. $51,000 is the maximum allowed limit for any employer/employee. Non-elective contributions, matching contributions or profit sharing contributions are all included as the employer component.

Investments 

As per the provisions of the government plan document, plan contribution can include bonds, stocks and other investments apart from, typically, investing in a portfolio of mutual funds.

Rules of distribution

For 401 (k) the distribution rules are different from the IRA’s distribution rules. IRA distribution can be made anytime but under 401 (k) there is a particular event which shall be fulfilled for distribution to take place. The following conditions are essential for withdrawing 401 (k) assets:

  • When any employee retires, dies, gets disabled or is separated from the employer
  • When the employee attains 59.5 ages
  • If the plan allows withdrawal in hardship, one can utilize fat
  • When the plan is terminated

Only when the employee remains employed and RMDs is allowed to be deferred till retirement. The distribution is considered as normal income and 10% is deducted as an early distribution penalty, before the attainment of 59.5 until an exception applies. The following is included as an exception:

  • After the disability or death of an employee, this distribution occurs.
  • If the employee attains 55 years of age, distribution occurs on separation from the company.
  • Under a qualified domestic relations order (QDRO), distribution is given to the replacement payee.
  • When an employee has deductible expenses of medical of more than 7.5% of adjusted gross income.
  • Series of equal regular payment.
  • Deferrals and excess contributions should be timely corrected.
  • IRS levy on the account of the employee and distribution occurs due to this.
  • It is tax-free

Only IRS provides exceptions for first-time home purchases and higher education expenses.
Most of the retirees choose to overturn the amounts to a Traditional IRA or Both IRA, who draw income from their 401 (k). The investment choices which are limited and are that are generally presented in 401 (k) can be escaped through a rollover. One can take advantages of “net unrealized appreciation” rule (NUA) and receive capital gains treatment on the earnings.

Loans

Another way to access plan balances is plan loan but this comes with some restrictions.

Firstly, no loan will be available if the employer chooses not to allow plan loans as this option is available only at employer’s preference.

50% of the employees balance can be accessed, if this option is available, so long as the amount is not more than $50,000 and also this has to be paid within five years.

Where as the loan which is used for purchasing a home can be paid over a longer time. Here the rate of interest should be equal to the rates charged in the market. The balance which is not paid at the end of the term may be considered a distribution and therefore, it will be penalized and taxed consequently. Online tax tools are an easy way to quantify the taxable income.

High-Income Earner’s limit

Contribution limits for high income employees are very high which allows tolerable levels of income delay.

The dollar contribution limit which is imposed on 401 (k) can be disadvantageous for employees whose income is some hundred thousand dollars per year.

For example, an employee whose income is $750,000 in 2013 can only include the first $255,000 of income for considering the maximum possible contributions to a 401 (k) plan.

Non qualified plans, like deferred compensation or executive bonus plan, can be provided by employers for the employees to allow them to save the extra income for retirement.

To sum up, 401 (k) plans have and will continue to have a major role to play in retirement planning and therefore, it becomes essential for an individual to understand it.

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