What Is a 401(k)? Why 401(k) is beneficial for everyone?
401(k)s are saving and investing plans which have been a part of the tax code since 1978. Though not specifically created as traditional saving plans, both US employers and employees have adopted the creation of the 401k as an opportunity to save money for retirement with benefits for both parties.
401(k) Investments Plan Information and Benefits
What a 401(k) offers to employees is the possibility of saving money from their payroll without paying taxes. In other words: employees can choose how much they want to transfer to their 401k savings plan before the government takes its cut from gross earnings. On top of that, there are no payable taxes on the money an employee keeps in a 401k until the moment they withdraw it (after retirement).
A 401k gives the employer a tax benefit when they contribute to their employees pension by ‘matching’ the employee contributions made from payrolls. Said simply: if an employee decides to contribute 15% of their monthly salary to their 401k, and the employer equals that amount, then the employer will benefit from a tax relief from the government. It is worth noting that under this type of defined-contribution plan employers are not required to match contributions, they are free to choose whether to match contributions or not. A 401k can be a win-win for both employee and employer; and the government finds satisfaction knowing that US citizen’s 401k savings are protected and guaranteed.
When Can Employees Withdraw their Money from 401 (k) Retirement Plan?
Ideally, the money deposited into a 401(k) plan will not be withdrawn until the employee reaches the retirement age (59 1/2) or the age 70 1/2. According to the IRS, at the age of 70 ½ the IRS will enforce a required minimum distribution, which means you must begin withdraws from your 401k. If you do not make such withdraws, you may have to pay a 50% excise tax on the amount not distributed as required. However, there are some conditions that could allow an employee to access their 401k savings if needed. It is not easy, but still possible. Some of those conditions refer to unavoidable payments that have to be done, such as medical expenses, college tuitions, funeral and burial expenses or those which would prevent foreclosure or eviction. These withdrawals would be subject to ordinary income taxes and possibly a 10% penalty for early withdraw.
Some of the few scenarios that allow money withdrawals before retirement without paying a penalty fee are employee’s death and employee’s total and permanent disability. Otherwise, there is a 10% penalty fee for early withdrawals.
A 401(k) is considered a long-term savings plan rather than anything else. Why should employees go for them anyway? Well, they provide employees with some tax advantages that allow individuals to increase the amount of money they are saving on a monthly or yearly basis, and nowadays many companies contribute to those savings because of the same tax advantages they get from that.
401(k)s as Investment Tools
401(k) plans are best for individuals to invest their contributions, or part of their contributions, into a portfolio of diversified assets such as stocks, bonds or any other investment products. Investing 401(k) contributions is a way of possibly getting some extra value for money without paying taxes on the profits, as the profits are considered part of the 401(k) plan and therefore no taxes would apply. Employees can choose the risk level they want to take when investing and their money is invested accordingly.
If authorized by an employer, 401(k)s may frequently be used as a way to access personal loans. Many employees avoid financial institutions and use part of their contributions to the 401(k) when, for example, they decide to buy a car or renovate their house. Interest rates on those loans may be determined by comparing with other financial institutions and their conditions on similar products. There are usually several restrictions regarding repayment periods and amounts, but, it is still another benefit of a 401k plan.
If you are thinking of investing in a 401k, speak with your employer on the various terms and conditions related to investing under the plan. When done right, a 401k might be right for you and your future.