A 401(k) is a type of employer
sponsored retirement plan
that allows employees to save and invest for their own retirement. Through a
401(k), you can authorize your employer to deduct a certain amount of money from
your paycheck before taxes are calculated, and to invest it in the 401(k) plan.
Your money is invested in investment options that you choose from the ones
offered through your company's plan. You decide how much money you want deducted
from your paycheck and invested during each pay period, up to the legal maximum.
You also decide how to invest that money, choosing from your plan's different
investment options. The money you contribute to your 401(k) account is deducted
from your pay before income taxes are taken out. This means that by
contributing to a 401(k), you can actually lower the amount you pay each pay
period in current taxes. For example, if you earn $1,000 each paycheck, and you
contribute, say 5% ($50), you are only taxed on $950. You don't owe income taxes
on the money until you withdraw it from the plan, when you could be in a lower
tax bracket.
What is
a 403(b) plan?
A 403(b)
plan is a retirement plan for certain employees of public schools,
employees of certain tax-exempt organizations, and certain
ministers. Individual accounts in a 403(b) plan can be any of the
following types:
An annuity
contract, which is a contract provided through an insurance
company,
A custodial
account, which is an account invested in mutual funds, or
A retirement
income account set up for church employees. Generally, retirement
income accounts can invest in either annuities or mutual funds.
The features of the 403(b) plan are very similar to the 401(k)
Plan. Employees may make salary deferral contributions, which is
usually limited by regulatory caps.
Contribution Limit:
You can have your employer deduct a percentage of your pay before taxes and
invest that money into your retirement plan account, up to the amount allowed by
your plan. That amount cannot exceed the annual IRS dollar limit which is
$12,000 for 2003. Thereafter, the new tax law increases the maximum amount you
can contribute by $1,000 for each year through 2006, to $15,000. After 2006,
these pre-tax contribution limits will be increased in $500 increments to factor
in the effects of inflation. It's important to remember that your
employer-sponsored retirement plan(s) may have lower limits.
Some companies offer a "match"
or "matching contribution" as an incentive to join the company
retirement plan. It means that the company will contribute a certain amount to
your account (usually between $0.25 and $1.00) for every dollar that you
contribute, up to a certain limit. The match formula can vary. To receive the
matching contribution, the plan may require that you work a specified number of
years. It makes good sense to take advantage of a company match by setting aside
the maximum amount required to qualify for a matching contribution. If your
employer offers a matching contribution, your savings can grow that much faster.
It's important to note that you may not
receive all of the matching contributions when you leave your job. That's
because most companies require you to wait before all of company's contribution
is yours (called vesting). There are 2 types of vesting: cliff
vesting and graded vesting. With cliff vesting you receive 100 percent ownership
of your company's matching contributions all at once and it cannot take more
than five years at the job. With step or graded vesting you gain ownership over
your company's matching contributions gradually. With each step, you get a
percentage of it. For example, 20 % in 2nd year at the job, 40% in 3rd year and
so on. Whatever vesting arrangement it uses, the plan must spell out all of the
details in its summary plan description.
Taking your money out: Because company retirement plans are designed to help you save for
retirement, tax laws require that you pay an early withdrawal penalty for most
withdrawals made before age 59 1/2. This penalty is intended to discourage early
withdrawals and to help you save for your retirement. So, in addition to the
ordinary income tax that you would pay on any pre-tax contributions and earnings
you may also owe a 10 percent penalty on an early withdrawal. You can take out
your money if it qualifies as a hardship withdrawal. Below
are four expenses that qualify as an immediate and heavy financial need.
Paying for medical expenses that
exceed 7.5 % of your adjusted gross income. The expenses can be for you, your
spouse, your kids, or other dependents.
Paying for tuition, related
educational expenses, and room and board for post-secondary education. These
can also be for you or your dependents.
Down payment for purchasing a
principal or primary residence (not a vacation home).
Preventing an eviction or
foreclosure on your home.
You must use up all your other
financial resources, including insurance and a loan from your plan before you
can take a hardship withdrawal. You may also still owe income taxes and a
possible 10% early withdrawal penalty if you are under 59 1/2 when you file your
annual income tax return. Therefore, make sure you really need the money before
you take a hardship withdrawal.
Borrowing from your 401(k):
Another way to take your money out of your account is to take a loan from your
401(k).
If your plan allows for loans (not all plans do), the most you can borrow is the
lesser of 50 percent of your vested balance or $50,000. Any loan balances over
the previous 12 months may reduce the amount you have to borrow. When you take a
loan from your account, you actually take money out of your account, with a
promise to repay it. You pay your account back the amount you borrowed plus
interest, through automatic deductions from your pay or bank account, or through
coupon payments. The interest you pay your account is not tax-deductible and is
paid with after-tax dollars. As long as you repay your loan on time, you won't
be subject to withholding taxes or penalties, as you would if you withdraw from
your account before retirement.
This is an ultimate beginner's guide to profiting from
401(k)s: How much to contribute, how to diversify, tax information, when and how
to borrow, changing jobs, and much more.
There are some additional things to keep in mind when considering taking a loan.
First, check with your employer to find out what the rules are for repayment if
you leave the company before repaying your loan in full. If you decide to leave
your employer, you must repay your loan in full immediately or within a certain
amount of time (depending on the provisions of your plan). If you are under age
59 1/2 and you do not repay your loan within this certain time frame, the
pre-tax portion of your loan is then considered an "offset distribution." This
distribution is subject to a 10 percent early withdrawal penalty as well as
current income taxes unless you rollover the outstanding balance to an IRA or
another employer-sponsored retirement plan within 60 days. Some employers treat
loan defaults differently, and some charge fees for taking loans.
Second, you should note that while it may seem like a loan is tax-free, it
isn't. Over time, you will pay taxes on the money twice. First, loan repayments
are deducted from your paycheck after income taxes have been withheld, then as
repayments are reinvested in your account they are characterized as pre-tax
money. So, when you withdraw from your account, you will pay taxes on the money
again.
Lastly, consider the possible long-term effects a loan can have on your account
balance. Although a loan may be a practical option when you need financial
assistance, you could miss out on the full growth potential of your principal
over the long term. In other words, the money you take out of your account
immediately loses its earning potential. And while you're paying interest on the
loan, it's important to remember that the interest is coming out of your own
pocket.
What's
the difference between a 401(k) plan and my company's profit
sharing plan?
A "profit
sharing plan" is a type of retirement plan. It allows an employer
to share profits of the company with employees by contributing a
percentage of the company's annual profits to the plan. The amount
of the contribution can change each year, or may not be made at
all, depending on the company's circumstances.
A 401(k) plan is a feature of a profit sharing plan or a stock
bonus plan. Unlike a profit sharing plan, however, employees can
contribute a percentage of their own salaries (up to certain
limits) to the plan for retirement savings. 401(k)s also allow
employers to contribute money to its employees' accounts in the
form of "company match" contributions, usually as an incentive to
get employees to participate in the plan. Current income taxes are
deferred on both employer and employee contributions and all
investment earnings, until the money is withdrawn from the plan.
Spend less than you earn! People who spend every penny
they make usually end up going broke.......
Take enough risk on the money you save! Playing safe by
putting your money under the mattress or in a savings account
will not make you wealthy..
Remember that.....Fully one-fifth of humanity, some 1.3 billion people,
struggles to survive on less than $1 per day. About 40% of
humanity survives on less than $2 per day. More than a billion
people around the world will go to bed hungry tonight. Life
expectancy in some 32 countries is less than 40 years. If you
have a few extra dollars in your pocket (you don't have to be a
millionaire to make a difference), please share some of your
financial good fortune with others who are in great need.
Think About It... Being in the 'now' brings a freedom, unlike living
in the past or in the future, which is a kind of imprisonment.
This isn't a kind of a denial where you pretend life doesn't have
problems. Life is full of problems, but most of those stresses
and failures are reliving old hurts or worrying about future
concerns. -- Carl Honore
When you 're diagnosed with cancer, you start to
bargain with God: "Let me get through this, and I'll take better
care of myself. I'll get my priorities in order. I'll learn to
live every day to the fullest." Isn't it sad that you have to get
sick before giving yourself permission to live life to the
fullest? -- Robert Schimmel
Look at Life in different & Positive ways
