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by: Radhika Pradhan-Chitnis
What are 401(K) plans?
401(K) plans are tax-deferred retirement savings plans
for employees. The employer sets them up and each company
has a slightly different 401(K). They are part of a
family of retirement plans known as "defined contribution"
plans - the amount contributed is defined by the employer
or the employee. 401(K) gets its name from the section
and paragraph of the Internal Revenue Code - section
401, paragraph K.
How do 401(K)s work?
When you join a 401(K) plan, you tell your employer
how much money you want to contribute to your account.
This amount is deducted from your salary before taxes
are applied, so you pay less income tax. More importantly,
the money is deducted even before you have received
it, making it the easiest savings plan to contribute
to. Your employer (usually) matches a portion of your
contribution. The money is invested by the plan administrator
(on your behalf) in mutual funds, bonds, money market
accounts, etc. You decide the mix of investments. They
usually have a list of investment vehicles you can choose
from as well as some guidelines for the level of risk
you are willing to take. Since the plan is an incentive
for retirement savings, there is one condition: if you
withdraw the money before you are 59.5 years old, you
will have to pay tax as well as a 10% penalty fine to
the IRS.
Why should you invest in a 401(K)
plan?
There are several reasons why investing in a 401(K)
plan is advantageous to you:
- The money you contribute is free from Federal and
State taxes.
- Your employer receives tax benefits for contributing
to your 401(K) - this is extra money for you
- There is a range of investment options and an expert
does the actual investing according to your directions.
- Any gains and earnings through this investment
are also tax deferred.
- You can take loans and hardship withdrawals from
your 401(K) under certain circumstances
- The money is deducted even before you receive your
salary, thus making it easy to stick with regular
saving and investing
When to invest in a 401(K)?
It will depend on your company's policy. Many companies
require that new employees complete six months to a
year of service before they are eligible to participate
in the 401(K) plan. Speak to someone in the Human Resources
Department of your company to find out how things work.
How much money can you contribute
to your 401(K) plan?
You are usually allowed to contribute between 1-20%
of your salary into the 401(K). The maximum pre-tax
dollar amount is set by law and adjusted for inflation
annually. It all depends on the restrictions of the
401(K) plan your company offers. For more information,
contact your Human Resources Department.
Can you withdraw or borrow money
from your 401(K)?
Remember that the 401(K) plan was devised as an incentive
for retirement savings. If you withdraw money from your
401(K) before the age of 59.5, you will be required
to pay tax and a 10% penalty fine to the IRS. However,
there are certain circumstances under which money can
be taken from your account prior to retirement:
- Loans: Some 401(K) plans allow you to take a loan
against the money you have contributed to the plan.
Every company will have its own rules for the loan.
Usually they require that there is an extreme hardship,
such as health problems, financing a home or such
other emergency. Check with your Human Resources Department
for details.
- Hardship Distribution: Some plans allow for a withdrawal
in extreme hardships - illness or great financial
need. Not all plans do this and usually, if this option
is used before the age of 59.5 years, a 10% penalty
fine is assessed on the withdrawal. You might have
to pay the applicable income tax and will most probably
not be allowed to participate in the 401(K) plan for
six months. Check with your Human Resources Department
for details.
- Distribution upon termination of employment, death
or disability: In case of termination of employment,
you have the option to take a cash distribution of
your funds from the 401(K). If you choose this option,
20% of the money may be held for income tax and the
10% penalty fine may be applicable if you are under
59.5 years of age at the time of withdrawal. In case
of death or disability, you or your beneficiary can
take the distribution. The 20% income tax may apply.
If you wish to avoid this taxation, you must invest
the money in a qualified retirement plan within 60
days.
What happens to your 401(K) if
you change/leave/lose your job?
You have three options:
- Keep your money in your former employer's 401(K):
You have to have a vested amount of at least $5,000
in your account to choose this option. Also, you have
to be under the plan's normal retirement age. If your
vested account balance is under $5,000, you may be
forced by the employer to take a distribution. Speak
to your HR Department for details about forced distribution.
- Roll the money over into a new 401(K): If you choose
this option, make sure that the check is written directly
to the new 401(K) account. There is no grace period
for this option. If the money comes to you before
it is placed in the new account, you will be charged
the income tax and 10% penalty fine.
- Cash out: you can withdraw the money in your 401(K).
However, if you are under the age of 59.5, the income
tax and 10% penalty fine will apply. If you are 55
years or older, you can begin tapping into your 401(K)
and the 10% penalty will not apply. It doesn't matter
if you left the job or were fired or retired. However,
you will still have to pay the income taxes on your
withdrawals.
Check with your HR Department for details and specifications
for these conditions
What happens to your 401(K) if
your company goes bankrupt?
If your company goes bankrupt or is bought by another
company, the contributions made to a 401(K) plan are
held in trust by an independent custodian. Your employer
does not have access to these funds. So, whatever the
circumstances, the money in your 401(K) account remains
yours.
What happens to your 401(K) if
you leave the USA country?
Your status (Resident/H-1B or other visa/Citizen etc.)
in the US at the time of contribution to the 401(K)
and at the time of withdrawal is considered. It is best
to consult a competent accountant or immigration lawyer
about this matter. You have a few options:
- At the time of leaving, if the amount vested in
your account is more than $5,000, you can leave your
401(K) money in your former employer's plan.
- You can take the lump-sum payment of the money in
your account. You will have to pay the taxes and penalties
associated with early withdrawal.
- You can directly rollover the amount in your 401(K)
account into an Individual Retirement Account or IRA.
Please remember, your Social Security Number is always
valid (whether you live in the US or abroad), however,
your finances and investments here are affected by
various factors including your status in the US and
how often you visit or live in the US among other
things. It is best to consult experts in the field
before making these important decisions.
. 401(K) glossaryof terms:
Defined Contribution Plan: A type of retirement
plan that specifies the contributions made to the plan,
either as a flat dollar amount or as a percent of compensation.
IRA: An individual retirement annuity or an individual
retirement account. A tax-qualified retirement savings
vehicle that is maintained by an individual and generally
is not sponsored or contributed to by an employer. Depending
on your adjusted gross income, you may be able to contribute
money to an IRA in addition to the amount you save in
your 401k plan
Qualified Retirement plan: An employee-sponsored
retirement plan you may purchase on pre-tax basis which
provides tax-deferred earnings.
Rollover: An individual, or nonqualified, retirement
plan moved from one trustee to another because of changes
in your employment status.
Tax Deferred Investment: An investment where
earnings are not taxed as they accumulate. Taxes are
deferred or delayed-generally until you receive a distribution.
You contributions to a 401(k) plan or traditional IRA
are examples of tax-deferred investments
Vesting: The "vested" portion of your
401k account is the part that is yours and that cannot
be forfeited. To better understand, consider that there
are two types of 401k contributions: the contributions
you make and the contributions your employer makes (such
as "matching" contributions).
 Useful
Links
- Website of Profit Sharing/401(k) Council of America
(PSCA), a non-profit association of businesses.: www.401k.org
- Website of American Pensions, Inc., a provider
of 401k administrative and investment services. Their
401(K) FAQ is quite useful www.401kfocus.com
- Dept of Iternal Revenue Services(IRS): www.irs.gov
Note : This
article is for information purpose only. Path2usa.com
or the author are not engaged in rendering legal advice.
We are providing you with general 401(k) information.
For specific information applicable to you, you should
consult a qualified financial advisor /CPA, your employer
or a lawyer..
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