The federal government established the 401k plan as a way for people to save for their retirement.
In order to encourage savings, the government created special tax advantages for 401k participants.
Your 401k plan is an incredible investment opportunity designed to assist you in reaching your retirement
goals. Every company's 401k plan is a bit different, however. It was set up by your employer as a simple,
convenient retirement savings vehicle that delivers significant tax benefits while you are working. It enables
you to build personal wealth in the future.
Your Summary Plan Description (SPD) will provide you
with more detail on the specifics of your plan. Ask
your Human Resources Department for a copy of this document.
A 401k plan is a retirement plan set up by your employer. When you join a 401k, you agree to contribute part of your salary to the 401k account. The money you contribute to your 401k is deducted from your paycheck before income taxes are taken out, so you end up paying less income tax. Additionally, you don't pay taxes on the money you contribute (and any interest it earns) until you withdraw money from your account at retirement -- so you enjoy the benefit of several years worth of tax-deferred compounding (which means your savings add up quickly!).
Each company's 401k plan has different rules, so the best source of information on your plan is the Summary Plan Description document. You can get a copy from your company's Human Resources Department or your benefits representative.
Your 401k plan helps you to start and stick with regular investing. Your contributions are
automatically deducted from your salary before you receive your check. Since the money is
deducted from your gross income, you will have lower taxable income, which means you will
pay less in annual taxes. You couldn't ask for a simpler way to save!
The money you save will accumulate on a tax-deferred basis. This means you pay no Federal
or State taxes on your contributions or investment earnings until you start withdrawing money
from the plan. The benefit of a tax deferred account is that your dollars accumulate more
quickly because your earnings are exempt from current taxation.
Your 401k account will have no effect on the amount of Social Security benefits you will be able
to receive. However, it is important to realize that Social Security is not intended to provide
for your entire retirement, but is meant to serve as a supplement to other income sources. For
example, if your current income is $30,000 per year, the benefit you receive from Social Security
will be approximately 40% of this, or $12,000 per year. This percentage varies according to your
income. Hence, if you'd like to maintain the same standard of living you had while you were
working, you do not want to rely on Social Security to be your only source of income after
Legally, all a participant is required
to receive is a Summary Plan Description, a Summary
Annual Report and an annual statement. You might not
receive a prospectus for every fund offered in the plan,
but if your company's stock is offered in the plan you
must receive a prospectus (or prospectus substitute)
for that. Luckily for participants, most plan sponsors
provide participants with a lot more information than
required. Keep in mind that often if you need more information,
all you have to do is ask.
That depends on the rules of your specific plan. Many companies require new employees to
complete six months or even up to a year of service before they're eligible to participate.
Some companies also require employees to be at least 21 years old to participate.
Ask your company's Human Resources Department or Benefits
Representative for information on your plan. This information
is also available in your Summary Plan Description.
All the contributions made to a 401k account are held in trust by a custodian separate
from the company sponsoring the plan, meaning that your employer does not have access
to any of the money that is contributed to your 401k. In other words, regardless of
whether your employer goes bankrupt or is bought by another company, the vested amount
of money in your account is always yours.
If you are under the age of 50, the
2010 limit for contributions to your 401k plan is $16,500.
This limit is generally adjusted for inflation in $500-$1,000
increments annually. In addition, Highly compensated
employees are usually limited in how much they can defer
due to IRS testing requirements.
If you are over the age of 50, you now also have the
option of making "catch-up contributions" in order to
accelerate your savings. As mentioned above, the maximum
amount of employee contributions for the year 2010 is
$16,500. However, if you are over 50, you have the option
of contributing an additional $5,500, bringing the limit
up to $22,000. Similar to the increases in the contribution
limits, this "catch-up contribution" amount may also
be adjusted annually for inflation.
For more information, please contact 401(k) Focus or
your Human Resources Department.
People age 50 or older may make an
additional contribution above any IRS or Plan limit.
The Catch-up Contribution amount for 2010 is $5,500.
The Tax Credit for low income savers
is a temporary, nonrefundable tax credit for lower income
taxpayers who make salary deferrals to 401(k), 403(b),
457, SIMPLE or SEP plan, or regular or Roth IRA.
You should consult your tax advisor for more information on this credit.
To change your contribution amount, see your Human Resources Department.
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).
The money you contribute to the plan is always 100%
vested. In other words, whatever money you put into
the plan, adjusted for any investment gains or losses,
is always 100% yours.
The money your employer contributes, however, may be subject to a vesting requirement.
Vesting requirements are very common in 401k plans and simply mean that you must earn your
employer's contribution over time. For example, if you have only worked for the company for three
years, which equals 40% vested under your plan's vesting schedule, you would only be entitled to
$40 of every $100 contributed by your employer.
That depends on the rules of your particular plan. Plan sponsors have some flexibility
in deciding vesting schedules when the plan is set up. In some plans, participants are
100% vested as soon as they join the plan, while in others, participants have to
complete a set number of years of service before they're fully vested.
By law, all participants must be fully vested in the
plan matching contributions after six years of service
and other employer contributions after seven years of
service with the company. Additionally, there are a
few guidelines that typically apply to most plans. For
instance, in most plans participants automatically become
fully vested when they reach age 65, if they die or
become disabled, or if the plan is terminated.
Check with your company's Human Resources Department or Benefits Representative regarding the rules of
your specific plan.
Many issues need to be considered when
you are choosing your investment allocation. Two of
the most important factors that need to be taken into
account are how long you have until retirement and your
personal risk tolerance. If you have many years until
retirement (more than five is a good benchmark for some,
but 10 or more years is even safer), then you can often
afford to take more risk in your investments. However,
you do not want to be uncomfortable with your choices,
so you must find the perfect mix of investments for
you personally. Reading a fund's prospectus or speaking
with an investment advisor are just two examples of
resources that may help you in this decision. You can
speak to one of our investment advisors by calling 1-888-
321-401k during regular business hours. Don't forget-you
can always change your investment allocation if you
find that your first choice isn't working for you.
You may change your investment choices as often as you wish to. Simply log on to your account
or use our automated phone service, VoiceLink. You may access VoiceLink by calling 1-888-
321-4015. Both options are available
24 hours a day, seven days a week (except during scheduled maintenance times, which vary).
Your account will be exposed to a variety
of types of risk depending upon how you choose to allocate
your funds between investments. Investing in stocks,
for example, exposes you to the everyday volatility
of the market, but long-term they often tend to have
the highest potential for gains. If you choose to invest
in foreign stock, you run the risk that a political
problem may arise overseas or that exchange rates will
drop, thus affecting your return. If you invest in bonds,
there is a chance that interest rates drop, and the
possibility that inflation may be higher than your return,
meaning that you are actually losing money. There is
no way to escape the risk that your investments will
decrease in value, although some types of investments
are seen as "less risky" and others as "more risky".
Bonds, for example, are seen as less risky when compared
to stocks. However, generally speaking, the higher the
risk the higher your potential for greater gains. While
it is impossible to completely avoid risk, there are
certain things that you can do to decrease your chances
for losses in your account. Most importantly, avoid
putting all of your money into one fund, or one type
of fund. Spread your assets among a variety of funds
within your plan so that if one fund is not doing well,
you have a chance for your other investments to make
up for any losses. Bear in mind that everyone has a
different tolerance for risk and the closer you are
to retirement, the more closely you may want to guard
your amount of risk exposure.
While 401k plans were developed as
a means for saving for retirement, there are a few cases
where money can be taken from your plan before you retire.
- Loans: Some 401k plans allow for a loan
to be taken against funds you have contributed to
the plan. Each company has its own provisions for
loans and they often require that the money can
only be taken if there is an extreme hardship, such
as medical expenses, prevention of eviction or foreclosure,
purchase of a primary residence, funeral expenses,
or post-secondary education. To find out whether
your plan offers a loan provision, check with your
Human Resources Department or check your Summary
- Hardship Distribution: As the name suggests,
some plans allow for a distribution in times of
extreme financial hardship, such as those listed
above. However, not all plans allow for this, and
if this option is used before the age of 59½, a
10% penalty tax will be assessed on the distribution.
You will also have to pay applicable income taxes
and will not be able to participate in the 401k
plan for six months. Check with your Human Resources
Department or your Summary Plan Description for
more information specific to your plan.
- Distribution upon termination of employment,
death or disability:Upon termination, death
or disability, you or your beneficiary will have
the option of rolling over your account balance
into another qualified plan or IRA (not available
to beneficiaries other than your spouse), or taking
a cash distribution. If you choose to a cash distribution,
20% of your account balance will be held for income
tax purposes, in addition to a 10% penalty tax if
you are under the age of 59½ (does not apply to
deceased participants). In order to defer taxation
on a cash distribution, these funds must be deposited
in a qualified retirement plan of IRA within 60
days of the date of distribution.
If you switch jobs, you have three options for what to do with the vested portion of your
401k account. The following outlines your options and tax implications for each:
- If your vested account balance is $5,000 or more
and you're under age 65, you can leave your money
where it is, and taxes won't be due until you withdraw
money from the plan. If your vested account balance
is under $5,000, you may be forced by the employer
to take a distribution. Consult with your Human
Resources Department for more information on a forced
- You can roll your 401k account over into a rollover
IRA account or into your new employer's 401k plan.
If you request a direct rollover, meaning you have
the money transferred directly into the new account,
you won't owe taxes until you withdraw money from
- You may take a cash distribution for the full
amount or a portion of your balance and not roll
it over into a rollover IRA or another 401k plan,
However, cash distributions are subject to applicable
income taxes and penalties. For tax purposes, 20%
of your balance will be automatically withheld plus
a 10% early withdrawal penalty (if you are under
the age of 59½).
Yes, if your new company's plan allows rollovers. If you roll
over your 401k money into another company's 401k plan,
you maintain the account's tax-deferred status and
will not have to pay taxes on your 401k assets until
you withdraw money from the plan.
If your new company does not allow rollovers, you
have two other options that would allow you to maintain
the account's tax-deferred status:
If your vested account balance is $5,000 or more and
you're under age 65, you can leave your money where
it is -- and taxes won't be due until you withdraw
money from the plan.
You can roll over your 401k into a rollover IRA account.
If you request a direct rollover, meaning that the money
is transferred directly into the new account, you
won't owe taxes until you withdraw money from the
Once you have terminated employment with your company, you should be sent a distribution
package that details your options and also includes the forms necessary to obtain a
distribution. Remember that initiating the distribution is your responsibility so make sure
that your address is up to date with your employer as well as the administrator of the plan.
It never hurts to follow up to make sure your distribution package is sent to you and your
distribution is in process.
Many factors can affect how long it
takes for you to receive your distribution. First, each
plan has its own rules for how often distributions can
be done- monthly, quarterly (every three months) or
annually, for example. Keep in mind that a 401k is designed
for retirement and is not like a savings account at
a bank. You may have to wait anywhere from 30 days to
a year or more before receiving a distribution. Typically,
401k plans process distributions on a monthly basis.
For example, if your plan has a monthly distribution
frequency, you will receive a distribution following
the close of the month in which your correctly completed
distribution paperwork was received by the plan administrator.
Depending on many factors, distributions can take 30
to 60 days to process. To find out the frequency of
distributions for your company, consult your Human Resources
Department or your Summary Plan Description.
That depends on what you decide to do with your 401k money.
You have several options:
If your vested account balance is $5,000 or more and
you're under age 65, you can leave your money where
it is -- and taxes won't be due until you withdraw
money from the plan.
You can roll over your 401k into a rollover IRA account
or into your new employer's 401k plan. If you do a
direct rollover -- have the money transferred directly
into the new account -- you won't owe taxes until
you withdraw money from the account.
If you elect to take your money out of the 401k and
not roll it over into a rollover IRA or another 401k
plan -- you will owe all applicable taxes plus the
10% early withdrawal penalty (if you are under age
Ten percent of the untaxed money you withdraw, plus applicable federal,
state and local taxes on that amount. So if you withdraw $5,000 from your 401k before age 59
1/2, you would owe a penalty of $500 (plus applicable federal, state and local taxes on the
entire $5,000). To withdraw money before age 59 1/2 and avoid the 10% premature withdrawal
penalty, you have to meet one of the following criteria (subject to the rules of your 401k
You are totally disabled,
- you are deceased and your beneficiary is collecting the money,
- you're in debt for medical expenses that exceed 7.5% of your adjusted gross
- you are required by court order to give the money to your divorced spouse
(or to a child or dependent),
- you're separated from service (including permanent layoff, termination,
quitting, taking early retirement, etc.) and you're at least 55 years old,
- you're separated from service and you've set up a payment schedule to
withdraw money in substantially equal chunks over the course of your life
expectancy. (Note that as attractive as this option may sound, once you begin
taking distributions you are required to continue for 5 years or until you
reach age 59 1/2 -- whichever is longer.)
Any money withdrawn for the above reasons is still subject
to applicable federal, state and local income taxes.
The 10% penalty applies to the entire untaxed amount that you
withdraw. If you withdraw $5,000 from your 401k before age 59 1/2, you would owe a
penalty of $500 (plus applicable federal, state and local taxes on the entire $5,000).
If you've made after-tax contributions to your 401k, it gets a bit more complicated.
You do not have to pay the 10% penalty or any additional taxes on the
amount of your after-tax contributions. You do, however, have to pay the 10% penalty and all
taxes due on any interest earned and employer-matching contributions made as a result of your
after-tax contributions. If you're thinking "I'll just take out my after-tax contributions and
leave the earnings where they are" -- nice try, but no dice. For every after-tax contribution
dollar you withdraw, the IRS requires you to withdraw a proportional amount of the earnings,
To avoid paying current income taxes and the 10% penalty you can roll
your account balance over into an IRA. To learn how to open an IRA account and roll over your
401k balance visit the IRA Center