Chapter 19: 401(k) Plan

401(K) Plan

An employer established plan similar to an individual retirement account (IRA). It gives a special tax break to employees who are saving primarily for retirement. There is a Traditional 401(K) and a Roth 401(K).

100% Vesting (TEST)

You own all contributions including your own (always) and your employer's matching funds

401(k) Roth contributions

You can contribute to a Roth 401(k) account if these two things are true: -You are eligible to contribute to the company's 401(k) plan, and your company has chosen to make the Roth 401(k) available

Cliff Vesting

You don't own the matching funds until you've worked for the company for a period of time, but it can't be longer than 3 years - The time period RAISES a RED FLAG -This company probably has a high turnover rate

Annuity

A contract where you receive monthly payments for a lifetime or a specific amount of years. -Fixed annuity -Variable annuity based on the market

Similarities between Traditional & Roth 401(k)s

-There is no difference between contribution limits. You can put up to the limit in either account or shared, but the total cannot exceed the limit. -There is no difference in what is an eligible investment -There is no difference in matching contributions except that matching contribution by the employer must go into a traditional 401(k) account -All earnings are allowed to grow tax free as long as the account exists.

Employer Contribution

-most employers will match a certain % of your contribution -A typical match might be 50 cents to $1 for every dollar you contribute up to 6% of your salary. -The IRA sets limits, adjusted periodically for inflations, on how much an employee can contribute to a 401(K) each year -When an employer makes a contribution for you, it can only go into the traditional 401(K), not the Roth 401(k)

Portability

401(K) plans are portable. When you leave your employer you can take the plan with you. Or you can leave it there if you like the investments that the company has, but only if you have more than $5,000 invested, but you cannot add to it. -You can roll a traditional 401(k) into a traditional IRA; same with a Roth 401(K) -You can roll in into a new employer's plan if the new plan allows you to do this (but they may not have the same investments).

403(b) Plans

Defined contribution plans established by non-profit organizations, and are similar to 401(k) plans -These plans allow matching contributions from non-profit employers.

Section 457 plans

Companies that have a 401(k) plan are allowed to add a Roth 410(k) plan, but they are not required to. The basic concept is similar to the Roth IRA in that there is no tax deduction for your contribution, but no taxes due on the withdrawals.

Comparison

-Your contribution to a 401(k) are tax deductible, but contributions to a roth 401(k) are not. --Distributions from a traditional in taxable; from a roth they're not.

Facts about 401(K)

-The employer's plan may not discriminate against lower paid employees -Employee contributions to a 401(K) are tax deductible -Growth within the 401(K) is tax-deferred until you withdraw your money -You cannot put into more than 25% of your earned income which is counted w/your employer's contribution -Tax sheltered but you can only put your money in investments that have been approved by your employer (diversify! Don't invest in your company's stock, look at the fees) -If/ when you die, if you are married & have a 401(K) your SPOUSE IS THE BENEFICIARY. Federal law says that the spouse is the beneficiary UNLESS they waive their rights. -You generally cannot withdraw funds without penalty before age 59 1/2 except under special circumstances.

Loans from your 401(K)

If your 401(k) plan allows loans, you can borrow up to 50% of your vested balance, not to exceed $50,000. Loans must be repaid over no more than 5 years unless used to purchase a first home.

Vesting (p.198)

The retention or holdback by your employer of all, or part, of the employer's contributions to your account if you quit, are terminated or take early retirement. This is commonly found in 401(K) plans. - This is a method used by an employer to reduce turnover

Roth 401(k) Plan

The roth 401(k) plan possesses the sam premise as the roth IRA in that there is no tax deduction for your contribution, but no taxes due on your withdrawals. BUT - the income limit/phase out that applies to individual Roth IRAs does not apply to the Roth 401(k) plan.

Graded Vesting

You get a percentage of the employer's match each year. Usually 1/3rd of the employer's contribution per year for 3 years. -Probably the most common form of vesting

Warning about loans

You should avoid borrowing for 401(k) accounts because your repayments are not tax deductible. They are made with after-tax dollars. Worse, when you retire and take withdrawals, you'll pay tax again on the same amount.

401(K) benefits for you

Your contributions are tax deductible to you, but all withdrawals at retirement are taxable as ordinary income. -401(K) plans allow you to select the investment you prefer, but only from a list of approved investments provided by your employer -When you are eligible for the employer's contribution is is called VESTING.