What Everyone Should Know About 401(k) Retirement Plans
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by: DanielBeckett
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A 401(k) plan is one of a variety of employer-sponsored retirement plans. The funds transferred directly from wages into the 401(k) are generally tax deferred, meaning that taxes are paid when money is withdrawn, not when it is put in. This is generally to the advantage of the employee, as most retirees have lower tax rates than when they were working as a result of substantially lower overall income.
One of the largest advantages of a 401(k) is that many employers will match funds deposited up to a certain amount. Usually, the amount an employer will contribute are either half or the full amount that they employee defers, up to a certain percentage of the employee's full wage.
Taking Care of the Money
The funds of 401(k) plans are usually managed in only two possible ways. One is where there is a trustee who makes all the decisions - the manager or trustee is usually chosen by the employer. The other is the self-directed 401(k) where the employee gets to choose between a number of investment options that are made available to the plan participants.
Getting the Money Out
One of the big problems with 401(k) plans is the restriction on what can be done with the funds before the employee retires. Usually there are very stringent requirements that must be met before an employee would be allowed to withdraw the funds early. And, the federal government imposes a 10% tax penalty on top of the normal income tax that would be due if the employee takes the money early.
Some plans allow employees to take a loan from the 401(k) to temporarily withdraw funds as a result of an unexpected hardship. Taxes are still deferred on the money received, as the loan is not taxed, but a pre-defined interest rate is charged, which becomes part of the 401(k) balance. It is important that employees only contribute as much to the 401(k) as they can afford to spare, as either of these options ends up costing in the long run.
Moving the Funds Around
A 401(k) generally remains active, even if the employee leaves the company providing the account. When leaving their old employer, the participant can transfer their funds directly into an IRA (another form of retirement plan), or they can transfer the funds directly into their new employer's 401(k) plan, if their new employer offers one.
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