What You Should Know About 401(k) Retirement Planning
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by: RaymondCheung
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One of the most popular retirement plans operational in the USA and other developed countries which work on similar financial basis, 401(k) Retirement Plan is the first thing that comes to mind when an individual is planning to retire from active working life. First introduced in 1978 by IRC, or the Internal Revenue Code, the primary focus of the 401(k) Retirement Plan is to offer tax benefits to the individual on the sum of money which he is not withdrawing from his salary, but putting it aside for using after retirement. Currently this plan is implemented by the Employee Benefits Security Administration or ESBA under the Department of Labor.
The central corpus fund in the 401(k) Retirement Plan is generated by contributions made by employees through out the country as well as an equal contribution made by the respective employers. One could call this plan an employer-sponsored contribution plan. The biggest advantage of this plan, from the employee perspective is that his contribution towards the plan is completely free of tax, till such times that he withdraws his contribution from the corpus.
Hence, the 401(k) Retirement Plan defers tax until withdrawn. The allowable age for withdrawal is 59.5 years, but it can be withdrawn before that in case of hardships. These hardships include events like paying for mortgages, payments to avoid foreclosures, funeral expenses, educational expenses, home improvements and such other things. If the amount is withdrawn for such hardships, there is a 10% deduction from the distributed amount.
If someone plans to invest in a 401(k) plan early on, he or she stands to gain a terrific amount at the time of retirement. With 20 or 30 years of funding, the compounding of the 401(k) plan is phenomenal. This is because the employer tops the employee contribution, thus providing more than what the employee puts in. Also, the funds of the 401(k) plan can be moved from one employer to another, making it a very flexible plan.
One of the main advantages of the plan that makes it popular is the tax-free nature of the contributions before they are withdrawn. And since the contributed income is not taxed, the member is able to get bigger savings compared to other investment plans. This is perhaps the only financial planning strategy which is not deducted with taxes.
But you must know that this plan is a disadvantage if you have to withdraw the funds in the investment before the age of 59.5 years. There is a penalty of 10% on preterm withdrawal. Also, you must know that the Pension Benefit Guaranty Corp. (PBGC) does not insure this plan. Another disadvantage is that the employer will not allow the plan to take effect until the employee puts in a few years of service, as decided according to their company policies. So, until that time, it will be only employee contributions, while contributions from employer will only come when the period of service is completed.
The 401(k) plan opens different investment opportunities for the contributor. He can choose to invest his savings in any investment method including treasuries, money market, stock funds or bonds.
An employee, who is quite sure of staying for a longer period in the company where he is presently working, should consider the advantages of the 401(k) plan. It is a good investment option but try to weigh the advantages and disadvantages before you decide if the 401(k) is the right investment vehicle for you. There are lots of investment options available for retirement purposes but so far it is the 401(k) retirement plan that attracts employees because they are not the only one contributing to their retirement fund since the employer also contributes to the fund making. Consider these options and decide which will benefit you in the future.
About the Author
Raymond Cheung is a participating researcher for Retirement Planning Software and is an authority on subjects involving 401k retirement planning.
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