The Role of Your 401 (K) Plan in Retirement Savings

In the United States, a 401k plan is an employee sponsored retirement plan where a predetermined amount of money is set aside and invested to suit the investment needs of the employee. The employee contributions are tax-qualified and depend on the performance of the employer throughout the year. The employer typically pays the entire benefit while the employee takes the remainder in their paychecks. This plan can be an excellent way for an employee to build a nest egg for their later years, but only if the employee understands what they are getting into. If an employee does not educate themselves about how a 401k plan works they could very well lose out on money that could otherwise go to their children or other dependents.

 

A large majority of employees have no idea that what they contribute to their employer’s 401k plan will be taxed or whether any money will be match. Then you can even take your current IRA and roll it over into a 401k. This is largely due to the fact that the vast majority of companies do not make their employees aware of the potential tax implications of their plan. Many companies provide a variety of options when it comes to the amount of money that employees can contribute to their plans and rarely have a set maximum dollar amount. In short, an employee might think that a specific amount of money is available to them as a pension, but in actuality that plan might only be able to provide that dollar amount.

 

There are a number of simple steps that employers can take to ensure that their retirement fund investments are used in the best way possible. The most important step, perhaps, is to allow employees to easily access their retirement mutual funds through a website provided by their employer. Most employers offer this kind of web presence because it increases employee participation and creates a more cohesive and unified company.

Tax Brackets

Another important aspect of a correctly structured 401k plan, an ETF, and stocks and bonds, is the use of tax brackets. Tax brackets indicate how much of your investment will be tax deferred until it is made available for withdrawal. In order to keep their tax deferred until the appropriate time, employers should provide their employees with a calculators that allow these individuals to input their information and obtain an accurate assessment of how much money will be in each tax bracket during their working years. By providing employees with these calculators, it ensures that a company does not improperly classify its employees as long term tax drivers, resulting in those employees paying taxes they would not be otherwise classified as having. Additionally, if the company allows its employees to contribute a certain amount of money into their retirement funds without being taxed for it, this also increases the amount of money available to be withdrawn at retirement. If you find yourself in the upper tax bracket but have invested a lesser amount than you would in the lower bracket, the more you are subject to higher taxes when you withdraw.

Growth & Preservation

When considering the right combination of investments, as well as the proper classification and distribution of your investments, it is important to remember that both growth and preservation of your capital remain at the heart of a properly structured 401k plan. The growth of your savings and the preservation of your capital through withdrawals should be considered at the time of you selecting the appropriate combination of investments. Through a simple 401k plan, your money can be effectively invested and growth is the result. Conversely, in a complex plan, preservation of capital is achieved through the timely deposit of distributions made according to rules established by your custodian.

 

One of the primary incentives of maintaining a 401k or an individual retirement account is the ability to save for retirement. A large number of employees find themselves with less than enough money for their lifestyles after their initial retirement, and early withdrawal from the plan has come to be viewed negatively due to its negative consequences. Because of this threat, various measures have been put into place that limit the ability of employers to engage in early withdrawal.

 

One of these measures includes increasing the rate at which you pay Social Security and Medicare taxes. As stated above, the ability to withdraw funds at anytime without penalty or fees is important to many employees. In order to provide employees with this flexibility, the IRS has imposed a number of restrictions on retirement income and expenses. Among these restrictions are caps on investment earnings, contribution limits to a 401k and contribution rates for employer-provided retirement plans. For example, if an employee contributes five percent of his / her salary to a traditional 401k plan, he / she will be limited to contributing that amount for five years.

 

This five percent limitation does not mean that employees will necessarily be restricted to contributions that amount only to the fifth percent of their final retirement income. The actual contribution amount that you pay taxes at may very well exceed the fifth percent limitation. The bottom line is that you can withdraw your money without penalty or fees if you meet the contribution and retirement income limits specified in your 401 (k) plan. So if you feel that you are not able to contribute the maximum allowed amounts to your 401 (k) plan, but you have an intention of cashing out that money before you retire, you should take the steps necessary to ensure that you do not have to pay taxes at a very high rate when you do finally give it to the government. A simple way to do this is to invest it in an annuity plan that pays taxes at a much lower rate.