How are you saving for your retirement? Does your current employer offer a retirement Plan? Are you taking advantage of the tax deferred growth associated with retirement plan accounts? These are just some of the many questions you should be asking yourself when planning your retirement. There are many retirement strategies one can employ and a great way to start is to contribute to a 401(k) Plan. What is a 401(k) Plan and how does it work?
A 401(k) is a self-directed, qualified retirement plan established by an employer to facilitate future retirement benefits to their employees. The employee has the ability to defer a percentage of their compensation to a 401(k) account under their Employer’s plan. Plan contributions are often times invested in mutual funds, however, these investments can also include stocks, bonds and other investment vehicles; as long as they are permitted under the provisions of their employer’s governing plan document.
With a 401(k), there are distribution rules that the employee needs to be aware of and there are only a few instances when monies can be withdrawn. Withdrawal opportunities include the following upon the employee’s retirement, death, disability, separation of service with employer, as a hardship withdrawal (plan permitting) and upon termination of the plan itself. It is important to note that all distributions are considered ordinary income, unless considered a direct or indirect rollover.
One may withdraw from their 401(k) after the age of 59.5 without penalty. Any withdrawals that aren’t permitted before the age of 59.5 are subject to a 10% early distribution penalty. At age 70.5, unless the employee is still employed and they are not a 5% or greater owner in the business, they are mandated to begin withdrawing monies from their 401(k) in the form of a Required Minimum Distributions (RMD).
There are many inherent benefits associated with a 401(k) Plan. One of these great benefits is its qualified tax status. This means that all employee contributions are made on a pre-tax basis, which in effect actually lowers your taxable income by the amount of your contribution. For 2015, employees can contribute up to $18,000 of their W-2 income to their 401(k). Any employee above the age of 50 has the ability to contribute an additional $6,000 as a catch up contribution for a total of $24,000.
Not only does it lower your current taxable income, but it also gives the employee the opportunity to grow their 401(k) investments tax deferred until their retirement. Tax free compounding is a very powerful strategy and should be utilized in everyone’s retirement planning, when available.
Another notable advantage of a 401(k) Plan is a matching employer contribution. Although not mandatory, often times employers integrate an employer matching program to provide additional contributions to their employees’ 401(k)’s. It is very common for an employer to match the employees’ contributions up to a certain percentage. This means that the employer would contribute an amount to match that of the employee’s contribution, however, it would be capped at the percentage designated by the plan document. This is advantageous for someone looking to grow their retirement savings. This is essentially free money, an employee benefit, towards their retirement slated to grow tax-deferred. The employer matching contribution is a great incentive for their employees to continue contributing to the plan.
A 401(k) Plan account can play an integral role in your retirement planning strategy. If this type of plan is offered by your current employer, it is very important that you begin participating. If you would like to learn more about 401(k)’s, contact Mitlin Financial today at (631) 952-4466 x12 and learn if this is something you should implement in your retirement strategy. It is never too early or too late to begin saving for retirement!
Disclaimer: This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.