401 (K) is a retirement plan which benefits many employees and therefore it’s essential to understand the basics of it
Planning for retirement has always topped the priority list of individuals. However, it is 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 early starters things are different and they can always benefit from 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 is 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 does 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 401 (k) plans.
Since 1978, the 401 (k) plan has been the most employer-sponsored retirement plan which is most popular. Many workers use this service and hang on to 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 the 401 (k) plan helps billions of people with retirement plans.
401 (k) is an arrangement that 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 The amount is not taxable, to the employee, until the amount is not distributed or withdrawn from the plan. 401 (k) contribution can be made on an after-tax basis and the amount when withdrawn is without tax. 401 (k) plans are a sort of retirement plan called a qualified plan. Defined-benefit plans or defined contribution plans are two types of qualified plans.
In a 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:
The maximum amount that an employee can defer as compensation to the 401 (k) plan, for 2013, is $17,500. Staff, 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.
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 that 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 are 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 upon 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 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 advantage of the “net unrealized appreciation” rule (NUA) and receive capital gains treatment on the earnings.
Another way to access plan balances is a 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 the employer’s preference.
50% of the employee’s 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.
Whereas 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.
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.
Nonqualified 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.