What is a 401k and what are the Benefits
of this type of Retirement Account
March 30th,
2006
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Your employer more
than likely offers a 401k package. You know it has something to do with
retirement. The 401k helps an individual save for retirement and
usually there are some extra benefits offered by the company you work
with.
The government
wanted to get people to save for retirement. In 1978, The Tax Reform
Act was passed. It gave people a way to lower their state and federal
taxes and save for retirement at the same time. The name 401(k) got its
name from the Internal Revenue code from the section 401 and paragraph
(k). It wasn’t until 1982 when the 401(k) was offered for the first
time with a tax break. The final regulations for the 401(k) were
completed in 1991.
There are other
retirement plans available. That is where some of the confusion
begins;
there are IRA’s SEP’s and money purchase plans along with the 401(k)
plans. These plans are also called a “defined contribution plan”, which
means that the dollar amount is previously defined by either the
employee or the employer.
It is common to
find employers that offer 401(k) plans from a private sector
corporation. If you are self-employed you can set up a 401(k) plan for
yourself. If you are self employed you have more flexibility to the
contribution amounts. You can set up a 401(k) plan from many bankers,
mutual fund, or insurance company. The bank should have a person that
specializes in retirement planning. The banks would likely be the best
to work with in setting up a 401(k).
The 401(k) when
set up has an agreed amount “deferred” into the 401(k) account. Once
the funds are in the 401(k) account they are often able to be invested
in a mutual fund. If you work for a company this is usually set up for
you on the choices for the investment options. The mutual funds are
usually a varying selection of stocks, bonds, money market investments.
There is also an option to purchase the companies stock which can be a
risky investment.
There is a kind of
401(k) called a “trustee-directed” which means that the employer does
all the decisions on how the assets will be invested. The participant
of these kinds of plans should be wary of this kind of investment. The
more common type of 401(k) plans is called “participant-directed plans”,
which is the type that you should invest with as it gives you the
control.
Companies may try
to keep employees by offering a match in the contribution that the
employer makes to the 401(k) plan. This job benefit may help to keep
employees loyal to working for that company.
What happens when
you quit or get fired from a company and you have a 401(k) plan? You
are able to keep the 401(k) account with the company and it should stay
active, however some companies will charge a fee for the ex-employees.
You can transfer your 401(k) to another account. It is called a “roll
over”. You can also transfer the 401(k) into and independent IRA with a
financial institution.
There are perks to
the 401(k) because of the amount you can deposit in the account, along
with some companies matching your contributions up to a certain dollar
amount. You get a tax break, which can lower your tax bracket and save
you a bundle on your income taxes. If you are self-employed and want a
tax break this can be a strategy that your tax advisor can help you
with. You have to set up a 401(k) with the money invested into the
account by December 31st for the discount on that tax year.
When you reach the
age of 70 ˝ years of age you have to start taking out the funds. You
pay taxes on the money that is taken out of the account. The benefit of
a 401(k) is best started by a younger individual. The longer your
investments have to make a profit the more financial gain you have. The
401(k) is not taxed when it is in your account, so all the profits that
you receive and reinvest are not taxed until in comes out after you
retire.
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