401K

Over the years employers have moved away for fixed pension plans and become more dependants on employees contributing to their own retirement plans. As employees contribute the employer normally makes a matching contribution to the account some where between 1-6% of their annual income, but are not obligated to do so.

In 2004 the maximum contribution that an individual can make to his or her 401K retirement plan is $12,000 if they are under the age of 50 and $13,000 if over. In addition to this amount the employer is also eligible to contribute to the employees account. The matching is dependant upon the salary but total contributions cannot exceed $40,000 or $41,000 if the person is over the age of 50. Because the employer contributes to these plans they may choose to add a vesting schedule as well. This schedule is a time period that the employee does not have access to the funds the employer contributes. This contingency is in place in order for the employer to maintain the longevity of an employee.

Once the employee terminates service they have a few options to consider. First they can leave it where it is until the funds are needed or have the option to roll over the money in their 401K to an IRA where the individual has full control of whet the money is invested in whether it is an annuity or mutual funds. When an individual chooses to do this one option is placing the funds directly into a Traditional IRA as a rollover which must be reported to the IRS. In the state of California you may also have the option to purchase years from a pension plan provider such as CalPers if you are a state employee. This is some what of a new program and is called “buying airtime.”

Many 401K providers allow participants to take out a loan against the assets held in their account. When this occurs normally the participant can only borrow 50% of the available balance. There are many advantages to this type of loan. The two most recognized advantages are, first the interest charged is usually lower that what another financial institution may charge, and second the interest that is paid goes back into the participants account. Conversely if you fail to repay the loan and terminate your employment the loan becomes a distribution which is taxed and penalized by the IRS.

Not only do the participants of a 401K have the ability to save money for their retirement but they also receive a tax deduction. When money is withheld from an employees pay check it is done on pre-taxed money. This means that the gross compensation that has been taxed is less the amount sent to the participants 401K. By doing so the participant may substantially lower the rate of tax that they have to pay, thus receiving another benefit.