401(k) Plans Explained

401(k)s are employer-sponsored retirement plans. The contributions you make come out of your paycheck usually before taxes. That means your taxable income is lower and your tax burden is decreased.

Plus, since the money is coming out of your paycheck before you get it, you'll never even see it to miss it!

Many 401(k) plans give employers the option of matching a portion of the amount you invest. For example: your annual compensation is $60,000 a year and contribute 8% to your 401(k) plan, your annual contribution would be $4,800. If your employer matches that amount up to 3% of your compensation, that's an additional $1,800 going into your retirement savings. It's almost like free money!

Benefits of a 401(k)

  • Employees and employers can make contributions to the plan on a pretax basis, and contributions and earnings grow tax deferred until withdrawn
  • A 401(k) plan gives you control over your retirement plan by letting you choose from a variety of investments that may match your goals

Contribution Limits

The maximum amount an employee can contribute to a 401(k) plan is $17,500 in 2014.

Employee contributions, optional profit sharing and matching contributions cannot exceed the lesser of 100% of an employee's compensation or $52,000 in 2014. Employees over the age of 50 may contribute an additional $5,500 (2014).

Vesting

Vesting, or ownership of the account balance, is determined by the source of the money:

  • Contributions that you make are always 100% vested, meaning that you always own those amounts in your 401(k)
  • Contributions that your employer makes may follow a schedule where the vesting percentage increases every year you work for the employer, for as many as six years, until you own 100% of the account balance
  • Your employer chooses the vesting schedule that applies to your plan

Taking Distributions

Generally, you can begin taking normal distributions from a 401(k) plan at age 59½. If you take a distribution before age 59½, you may be subject to a 10% penalty.

Remember, though, that you must begin taking distributions by April 1st of the year after you reach age 70½ or retire, whichever is later. These distributions are commonly referred to as required minimum distributions (RMDs).

After that, you must take distributions annually by December 31. If you don't take the RMDs on time, the IRS may assess you a penalty of 50% of the amount that should have been withdrawn.

For more information on 401(k) plans, talk to your financial advisor today.         

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