Retirement Planning - 401(k) Plans
It is presumably everyone's wish that they are able to retire comfortably in their later years, having given perhaps the majority of their adult lives to their chosen profession and paid their dues along the way. Unfortunately however, as we all know, that is not the case for everyone. Many fail to plan adequately during their working years and so never get to experience the retirement they had envisaged.
Hopefully you will not be in that category and the fact that you are reading this article is a sign that you are making preparations for your future and looking for some advice along the way. This information focuses on 401(k) plans - their advantages and disadvantages, which will hopefully be of some help to you in your plans for the future.
Firstly, what is a 401(k)?
A 401(k) is a retirement plan sponsored by employers and is grouped into two categories - Defined Contribution and Defined Benefit. Probably the least complicated is the former where you are allowed to make your own contribution and your employer may also make matching contributions of a percentage of your input. At retirement you receive what you put in plus all accruals. The more you contribute obviously means the more you have for retirement.
The latter pension plan is much better for you the employee. In this case the employer promises to pay a defined amount to retirees who meet certain criteria. It links the benefit to the amount of service and is based on the final average salary. Employees can usually predict the monthly retirement income they might receive with this type of plan and might also be given the choice of a lump-sum benefit at retirement.
Where does the 401k get its name?
Rules and regulations for 401(k) plans are established by the US tax code. A 401(k) plan takes its name from the section of the 1978 Internal Revenue Code that created them. The operation of these plans is regulated by the Employee Benefits Security Administration of the U.S. Department of Labor.
A 401(k) plan is a plan qualified under Section 401(a) which is the section that defines qualified plan trusts in general, including the various rules required for qualifications. Section 401(k) provides for an optional "cash or deferred" method of receiving contributions from employees. So every 401(k) plan already is a 401(a) plan if that makes sense.
What are the Advantages of 401(k) plans?
There are many advantages to 401(k) plans:
1. Unlike a pension, if a participant changes jobs, all contributions can be moved from one company's plan to the next company's plan (or to an IRA)
2. If your company matches your contributions, it's like getting extra money on top of your salary.
3. As the employee is allowed to contribute to his/her 401(k) with pre-tax money, it reduces the amount of tax paid out of each pay check.
4. All contributions from employers and any growth in the capital itself experience tax-free growth until withdrawal. The compounding effect of consistent contributions over the period of 20 or 30 years is very significant.
5. The employee decides where to direct their future contributions and/or current savings, giving them substantial control over the investments.
6. Because the program is a personal investment program for your retirement, it is protected by pension (ERISA) laws.
7. Lastly, while the 401(k) is similar in nature to an IRA, an IRA won't enjoy any matching company contributions, and personal IRA contributions are subject to much lower limits.
Are there any disadvantages of 401(k) plans?
There are, of course, a few disadvantages associated with 401(k) plans:
1. 401(k) plans don't have the luxury of being insured by the Pension Benefit Guaranty Corporation (PBGC). (Having said that, some pensions don't enjoy this luxury either.)
2. It is difficult (or at least expensive) to access your 401(k) savings before age 59 1/2.
3. Employer matching contributions are usually not vested (i.e., do not become the property of the employee) until a number of years have passed. The rules say that employer matching contributions must vest according to one of two schedules, either a 3-year "cliff" plan (100% after 3 years) or a 6-year "graded" plan (20% per year in years 2 through 6).
Employees' choice of investments
Financial advisors typically say that the average 401(k) participant is not aggressive enough with their investment options. Historically, stocks have outperformed all other forms of investment and will probably continue to do so. Since the investment period of 401(k) savings is relatively long - usually 20 to 40 years - this will minimize the daily fluctuations of the market and allow a longer term "buy and hold" strategy to pay off. As you near retirement, you might want to switch your investments to more conservative funds to preserve their value, so for example if you are 10 or less years from retirement, you might want to invest say, up to half your capital in bonds with perhaps 30% in large cap stocks, and the remainder in smaller stocks and cash.
To sum up, 401(k) plans are generally very popular and an excellent means of planning for your retirement. As with any other form of investment however, you need to watch your portfolio very carefully as it is your money after all and ultimately your responsibility to oversee. I would always recommend seeking the advice of a financial advisor as well as doing plenty of personal research so as to make the wisest investment choices possible.
For lots of advice and information on retirement planning in general and on financial aspects in particular - 401(k) plans, IRAs etc, visit http://www.Planning-Your-Retirement.com straightaway!
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