What You Should Know About 401(k) Retirement Planning

The 401(k) Retirement Plan is the very first thing that comes into the mind of anyone planning his retirement. While this is a prominent retirement plan in the United States, it is also applicable in other countries with basically similar financial system as the US. Introduced by the Internal Revenue Code in 1978 and administered by the Employee Benefits Security Administration, it aims to provide employees with a retirement plan from their unclaimed or un-withdrawn salaries.

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.

With the 401(k) Retirement Plan, the government defers tax collection until the beneficiary withdraws his contribution. A contributor to the plan can only withdraw his investment when he reaches the age of 59.5 or before that in case of economic hardship. .Among those considered as economic factors that will allow the withdrawal of your 401(k) contributions are payments to avoid foreclosures, mortgages, home improvement, funeral and education expenses. However, a 10% deduction is taken from the amount distributed.

A person who intends to place his hard earned money on a 401(k) plan can expect to get a substantial amount upon retirement considering the phenomenal compounding of the plan after 20 to 30 years. The joint contribution between the employer and the employee becomes more, with the employee’s contribution topped by the employer. It is also a very flexible plan since the funds can be moved among different employers.

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of the main advantages of the plan that makes it popular is the tax-free nature of the contributions before they are withdrawn.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 increases your scope for investments, though. You can invest in mutual funds such as treasuries, stock funds, money market funds and bond funds. You may also invest in the stock of the company itself and in the American Savings Bonds. You have the liberty to choose which manner you want your savings to be made in.

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.

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