What Else Should You Know About A 401 Plan
Automation makes it easier to save
A 401 plan can help automate the retirement savings process through automatic payroll deductions. Employees in some plans can also choose to automatically increase their contribution by a certain amount every year.
Tax treatment in a 401
Contributions to a 401 plan are most commonly made through pretax¹ payroll deductions. 401 pretax contributions reduce taxable income and grow tax free until theyre withdrawn, typically at retirement. Allowing contributions to grow tax free over long periods may add up to a larger balance at retirement. For example, an employee with a $10,000 account balance making $1,000 in annual contributions for 20 years at an average annual rate of return of 8% would end up with more than $23,000 in a tax-deferred account than in a taxable one.²
Many plans also offer options for employees to make post-tax 401 contributions from their paycheck. Post-tax contributions dont lower an employees taxable income, but they do grow tax free and arent taxed on withdrawal.³
The power of compounding
Investing their retirement contributions gives employees the opportunity to grow their contributions. Earnings from those contributions can then be used to make additional investments, which can generate increased earnings, a process known as compounding. This calculator shows you how much your savings may grow over time, thanks to the power of compounding.
Leave Your 401 With The Old Employer
In many cases, employers will permit a departing employee to keep a 401 account in their old plan indefinitely, although the employee can’t make any further contributions to it. This generally applies to accounts worth at least $5,000. In the case of smaller accounts, the employer may give the employee no choice but to move the money elsewhere.
Leaving 401 money where it is can make sense if the old employer’s plan is well managed, and the employee is satisfied with the investment choices it offers. The danger is that employees who change jobs over the course of their careers can leave a trail of old 401 plans and may forget about one or more of them. Their heirs might also be unaware of the existence of the accounts.
Turn Your 401 Into Apension Plan
When 401 plans began replacing pensions as the primary retirement plan in corporate America, millions of Americans lost something valuable the opportunity to supplement their Social Security benefits with a guaranteed monthly pension check. Now, the financial services industry is developing work-arounds that make it cheaper and easier to convert your 401 balance into a guaranteed stream of income once you retire, much like what you would get from a traditional pension plan.
The typical American worker has three financial decisions to make in planning for retirement, says Bill McDermott, executive vice president and head of Corporate Markets for insurance company AXA Equitable. One is the decision to save, and the second is how to invest those savings. Employers have been very good about helping with those. But the third decision how to distribute the money that youve accumulated in your retirement account is just as important, and it has been largely unaddressed.
Currently, the Prudential retirement income product is available only to plan participants who are at least 50 years of age. However, Prudential is looking into a variation that would be available to participants of any age.
In addition to securing guaranteed growth of a notional income base and withdrawal guarantees with these new products, you also benefit from institutional pricing levels that may be lower than those available to many retail investors.
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One: How Will Working Families Fare In Retirement
The first section of the chartbook looks at the retirement prospects of working-age families, focusing especially on retirement account savings. Except for one, all charts in this section are based on data from the Federal Reserve Boards Survey of Consumer Finances . In the Survey of Consumer Finances, a family consists of an economically dominant single person or couple, whether married or living together as partners, and all other persons in a household who are financially interdependent with that person or couple. The familys age and education level are based on the age and education of the male in a mixed-sex couple or older spouse in a same-sex couple .
Most of the charts focus on retirement account savings, a measure that includes savings in 401-style defined-contribution plans, IRAs, and Keogh plans for self-employed people and small-business owners. The measure excludes assets held by defined-benefit pension funds, which are not account-type plans.
In addition to other demographic factors, the charts show trends in retirement preparedness by six-year age group or birth cohort from 1989 to 2013. Six-year groups were chosen because the Survey of Consumer Finances is conducted every three years, but six-year groups produce larger sample sizes. All charts use inflation-adjusted dollars and, where possible, are shown on comparable scales. Dollar amounts in charts may reflect rounding by survey respondents.
Key findings of the following charts include:
Taking Withdrawals From A 401
Once money goes into a 401, it is difficult to withdraw it without paying a tax penalty.
“Make sure that you still save enough on the outside for emergencies and expenses you may have before retirement,” says Dan Stewart, CFA®, president of Revere Asset Management Inc., in Dallas. “Do not put all of your savings into your 401 where you cannot easily access it, if necessary.”
The earnings in a 401 account are tax-deferred in the case of traditional 401s and tax-free in the case of Roths. When the owner of a traditional 401 makes withdrawals, that money will be taxed as ordinary income. Roth account owners have already paid income tax on the money they contributed to the plan and will owe no tax on their withdrawals, as long as they satisfy certain requirements.
Both traditional and Roth 401 owners must be at least age 59½or meet other criteria spelled out by the IRS, such as being totally and permanently disabledwhen they start to make withdrawals.
Otherwise, they usually will face an additional 10% early-distribution penalty tax on top of any other tax they owe.
Some employers allow employees to take out a loan against the money they have contributed to a 401 plan. Basically, they’re borrowing from themselves. If you consider this option, keep in mind that if you leave the job before the money is repaid, you’ll have to repay it in a lump sum or face the 10% penalty for an early withdrawal.
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How Is Your 401 Doing
Allocate your assets as you will, you can’t ever be 100% certain of the returns your 401 will generatethat’s why it’s called investing, not saving. But if you want a sense of how your portfolio is performing, you can, and should, make comparisons.
Specifically, you can compare the investments in your account to other mutual funds or ETFs that invest in similar assets , or have similar investment objectives . You can also see how a particular fund is doing compared to an overall index of its asset class, sector, or security type.
For example, if you owned a real estate fund, you might want to see whether it is underperforming or outperforming Dow Jones U.S. Real Estate Index , which tracks over 100 REITs and real estate companies. If you own broad-based equity funds, you can even compare them to the stock market itself.
Don’t be surprised, though, if your actual return lags the index by 1% to 2%. The cause is, in a nutshell, the annual fees charged by both your individual funds and by the 401 plan itself. Unfortunately, this sort of expense is pretty much beyond your control, and to be expected. However, if the index is up and your fund is down, be afraid, be very afraid.
Limitations Of A Qdro
Although there are benefits, there are also some limitations to a QDRO. Assets within a retirement plan will not be transferred under a QDRO if those funds are already promised to another alternate payee via another QDRO.
Also, only benefits that the retirement plan administrator offers can be included in the transfer of the assets. In other words, new benefits or choices can’t be added for the benefit of the ex-spouse if those benefits are not currently offered by the retirement plan.
It’s important to check the details within the pension or retirement plan. If contributions by the plan participant and the employer have been made for several years before the couple was married, those funds would not be included in the QDRO.
The amount of money paid out during the divorce settlement would be limited to the contributions during the marriage. If the participant wanted to protect their pension or retirement plan, they could offer the ex-spouse an alternative amount of assets such as the house or other savings.
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Pensions Don’t Allow You To Make Investment Choices
Chronic underfunding gets worse when paired with bad investment decisions, and history shows you can’t assume the person managing your pension will invest wisely. Unfortunately, the Center for Retirement Research reports the return on investment earned by public sector pension plans has fallen far short of actuarial estimates throughout the 2000s.
One reason pension plans have fallen short is that many plan managers overinvested in alternative investments, particularly hedge funds — 31% of pension plans have at least 30% of their assets in alternative investments. These investments have been hugely underperforming the stock market since 2010, in part because hedge funds charge relatively high fees that reduce returns.
401 accounts generally don’t offer the option to invest in hedge funds. Even if they do, you have the option to select your own investments, so you can steer clear. Most 401s offer multiple investment options for you to pick from, including index funds or target date funds that make it easy to maintain an appropriate asset allocation as you age. Since you have the option to choose your own investments, you can determine how much risk you want to take on and choose investments that are a good fit for you personally, whereas a pension invests for all company employees.
What Is A 401 Plan And How Does It Work
A 401 Plan is a retirement savings vehicle that allows employees to have a portion of each paycheck directly paid into a long-term investment account. The employer may contribute some money as well.
There are immediate tax advantages for the employee if the account is a traditional 401, and tax advantages after retiring if it is a Roth 401.
In either case, the money earned in the account will not be taxed until it is withdrawn during retirement if it is a traditional 401. If it is a Roth 401, no taxes will be due when the money is withdrawn.
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How Much Does It Cost To Offer A 401 To My Employees
401 fees can be tricky. In many instances, fees are deducted from participant accounts and are not very transparent. There are typically two kinds of 401 fees: investment and plan administration expenses:
- Investment expense: The investment expense ratio is the revenue the investment company collects to manage the fund . Investment expense is generally not visible as a fee to the employer or employees because the fee is netted from the funds return.
- Plan administration fee: The plan administration fee is the fee the provider collects for basic administrative services such as plan record keeping, accounting, legal and trustee services.
There Are A Few Ways Providers Collect Administration Fees:
- Flat dollar amount per participant: This is most equitable but it can be a deterrent for employees with smaller balances.
- Asset-based fee: A percentage of assets deducted pro-rata from participant accounts may work for some, but larger account balances will end up paying more.
- Revenue sharing from investment expenses: This method is least transparent.
High plan fees can significantly impact an employees retirement savings over time.
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Understand All Of Your Options
Before you make your final decision, you should consider getting professional financial advice to make sure you understand all of your options. Some employers may offer this service for free or for a low fee, as part of the benefits they provide to their employees. Therefore, you may want to check if your employer offers this service.
Move Your 401 To A New Employer
You can usually move your 401 balance to your new employer’s plan. As with an IRA rollover, this maintains the account’s tax-deferred status and avoids immediate taxes.
It could be a wise move if the employee isn’t comfortable with making the investment decisions involved in managing a rollover IRA and would rather leave some of that work to the new plan’s administrator.
In addition, if the employee is nearing age 72, note that money in a 401 at one’s current employer may not be subject to RMDs. Moving the money will protect more retirement assets under that umbrella.
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Third Party Administrators: Planperfect
It is important to have a retirement plan that works for you. Combination plans offer a solution that allows companies to combine some of the most powerful investment vehicles: a defined benefit plan and a defined contribution plan. PlanPerfect is with you every step of the way to streamline the plan design and administration process. Contact us today for a consultation!
How Do Benefits Work And How Can I Qualify
While you work, you pay Social Security taxes. This tax money goes into a trust fund that pays benefits to:
Those who are currently retired
To people with disabilities
To the surviving spouses and children of workers who have died
Each year you work, youll get credits to help you become eligible for benefits when its time for you to retire. Find all the benefits Social Security Administration offers.
There are four main types of benefits that the SSA offers:
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How Survivor Benefits Are Paid
As a plan member, it is important to understand how survivor benefits are paid to your loved ones.
- If you have a spouse on the date of your death, he or she will receive a survivor pension and/or a lump sum payment .
- If you do not have a spouse, your designated beneficiary will get a lump sum payment.
- If you do not have a spouse or a designated beneficiary, a lump sum payment will be made to your estate.
If You Die After Retirement
If you have a spouse when you retire, and you are receiving a pension from the pension plan, he or she is automatically entitled to a death benefit that is paid in the form of a joint and survivor pension.
The only exceptions are if and your spouse complete a waiver of the joint and survivor pension, or you are separated from your spouse, before the date when your first pension payment is due.
Some pension plans may offer more than one option. Your actual options will depend on your specific situation and the terms of your pension plan.
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How 401 Plans Work
The 401 plan was designed by Congress to encourage Americans to save for retirement. Among the benefits they offer is tax savings.
There are two main options, each with distinct tax advantages:
- A traditional 401 is deducted from the employee’s gross income. The employee’s taxable income is reduced by that amount and can be reported as a tax deduction for that year. No taxes are due on the money paid in or the profits it earns until the employee withdraws it, usually after retiring.
- A Roth 401 is deducted from the employee’s after-tax income. The employee is paying income taxes on that money immediately. When the money is withdrawn during retirement, no additional taxes are due on the employee’s contribution or the profits it earned over the years,
Not all employers offer the option of a Roth account.
If the Roth is offered, the employee can pick one or the other or a mix of both, up to annual limits on their tax-deductible contributions.
Key Factors To I& d Success
About three-quarters of HR professionals indicate that they have reviewed or will review some aspect of their plans from an I& D perspective. Thats an encouraging first step in the framework towards building I& D into benefits and retirement planning, says Mervyn. He lists five major focuses that can help navigate the process commitment from leadership, listening to stakeholders, reviewing whats being done, measuring outcomes to determine if things are going in the right direction, and communicating the results.
An important step in committing to the entire process is thinking about who the decision-makers are and if they are incorporating diverse and multiple perspectives, and are aware of any unconscious biases or blind spots that need to be mitigated, he says.
Ensuring that benefits and retirement plans are inclusive of the unique needs of diverse groups of employees and that those employees are properly educated and informed about them will allow those plans to be a part of the organizations overall I& D objectives.
People really want to work for a company that has strong inclusion principles, says Mervyn. And if you see an organization is doing that, even in things like their benefits and retirement programs, you really know that theyve taken solid steps to get there.
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