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Retirement Accounts

Stevie Chaikin. Retirement Accounts. 401(k). What are They Used for. 401(k) retirement savings plan allows a worker to save for retirement and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal.

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Retirement Accounts

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  1. Stevie Chaikin Retirement Accounts 401(k)

  2. What are They Used for • 401(k) retirement savings plan allows a worker to save for retirement and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal. • The worker elects how much money will be taken out of his income and put into his account. This is also called a “contribution”

  3. Where it Comes from • 401(k) plans are mainly employer sponsored plans; the employer can, as a benefit to the employee, optionally choose to "match" part or all of the employee's contribution by depositing additional amounts in the employee's 401(k) account or simply offer a profit sharing contribution to the plan. https://digitalcommons.georgetown.edu/blogs/csic/files/2008/12/401k.jpg

  4. History • In 1978, Congress amended the Internal Revenue Code by adding section 401(k), whereby employees are not taxed on income they choose to receive as deferred compensation rather than direct compensation. The law went into effect on January 1, 1980, and by 1983 almost half of large firms were either offering a 401(k) plan or considering doing so. By 1984 there were 17,303 companies offering 401(k) plans. http://atrocitynews.files.wordpress.com/2007/05/am.jpg

  5. There are Limits • Maximum limit on the total yearly employee pre-tax salary deferral. The limit, known as the "401(k) limit", is $15,500 for the year 2008 and $16,500 for 2009 and 2010. http://samuelatgilgal.files.wordpress.com/2008/12/401k.jpg

  6. Small Business • The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made 401(k) plans more beneficial to the self-employed. The two key changes enacted related to the allowable “Employer” deductible contribution, and the “Individual” IRC-415 contribution limit. http://www.401klookup.com/small-business-401k.jpg

  7. Tax Consequences • Most 401(k) contributions are on a pre-tax basis. Starting in the 2006 tax year, employees can either contribute on a pre-tax basis or opt to utilize the Roth 401(k) provisions to contribute on an after tax basis and have similar tax effects of a Roth IRA. However, in order to do so, the plan sponsor must amend the plan to make those options available.

  8. Pros of 401(k) • Tax-Deferred: Save on taxes now.  You will need to pay for it later though.  Your tax rate now will most likely be higher than during retirement.   If this is true, you’ll end up paying less in taxes and have more for retirement. • Automated Savings:  The savings come out of your paycheck so you never see it and it actually gets saved rather than spent. • You Can Save A Lot:  The amount you can save is decent.  In 2009 it is $16,500 and it tends to rise. • Free Money  (Sometimes):  Your employer may match your contribution.  In this case, it is free money until you hit the contribution limit.  ie.  If you employer has a 50% match up to $5,000,  and you contribute $5,000, they will add another $2,500 for a total of $7,500.  You should aim to get the maximum employer match whenever possible.

  9. Cons of 401(k) • You Do Pay Taxes Eventually:  In some situations, your tax rate now will likely be lower than during retirement.  This is more likely to be true if you are… • Early in your Career:   Your income is likely to grow by 2-3 times in the next 20-30 years. • Lots of Income Tax Deductions:  If you claim lots of income tax deductions due to a house or other reason that you don’t expect to have during retirement, your tax rate now may be lower than in retirement. • Fees:  Some plans charge an administrative fee of 0.5% on to of mutual fund expenses of 0.7%.  This can drag down your long term returns substantially. • Investment Choices:  Most plans offer 10-12 investment options.  The choices may not match your investment preferences or they may charge higher than normal expenses fees. • Mandatory Distributions:   When you are retired, you will be required to withdraw funds whether you need them or not and regardless of your tax situation.

  10. Alternates to your 401(k) • Roth IRA:  So you can pay your taxes later with a 401K or pay them now with a Roth IRA.  You need to earn less than $95,000 if you are single and $150,000 if you are married.  Otherwise, anyone can open this account at a brokerage and contribute up to $5,000 per year. • Roth 401K: This works similar to a 401K except you put funds in after you’ve paid taxes on them.  Then you never pay taxes again.

  11. Costs and Investment Risks • Besides the advantages offered by participation in a 401(k) plan, employees also may encounter certain costs and investment risks. Eligibility requirements, discretionary employee contributions, and matching company funds all can cause an employee to incur costs. In addition, investment risks, diversification or lack thereof, high record-keeping costs, the exercise of loan and withdrawal options, and fund distribution choices all can affect the level of an employee’s retirement benefits.

  12. End

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