Planning for retirement is vitally important in a world where little if any Social Security will be available when today’s young people are ready to retire. There are many options available, such as IRAs, pensions and 401(k) retirement plans. The 401(k) is perhaps the most advantageous plan available when looking at tax benefits.
The single best benefit to you today of a 401(k) is the opportunity to put money into your retirement savings while reducing your taxable income at the same time. The money you contribute, up to a certain amount, comes out of your earnings before tax.
For example, if your paycheck before any deductions would have been $1000 and you contribute $100 towards your 401(k), Uncle Sam only gets his fingers into a percentage of $900, not the whole $1000. This means that your pay will be larger than it would be if you took $100 out of your post-tax check and put it towards savings.
The fact that your 401(k) payments are pre-tax also affects your earnings at tax time. The maximum contribution of $16,500 could be enough to kick you into a lower tax bracket if you are lucky. At the very least the amount of tax you are responsible for is going to be less.
It’s easier to report it to Uncle Sam as well, since most employers include it on your W-2. If you are instead dealing with IRAs and other forms of savings, you will have to provide all of those tax documents to your tax preparer and make sure they are each reported in the correct section of the 1040.
Another great tax benefit is the tax-free money your employer will be contributing towards your retirement. If you are contributing the full amount allowed by the IRS towards your 401(k), $16,500 in 2010, and your employer is providing a 50% match, the most common amount, you are effectively raising your per-hour earnings by at least a few dollars.
For example, if you earn $100,000 a year and contribute the maximum of $16,500 towards your 401(k) this year, your employer could contribute a match of up to 6% of your income. At 50 cents on the dollar, that would be $3000 of extra income going towards your retirement this year alone.
The final tax benefit is the opportunity to grow your retirement savings without having to pay taxes on that amount as it grows. Capital gains, dividends and other type of distributions will all be put back into your 401(k) account and allowed to grow even more without being taxed.
Remember, you will of course be paying taxes on your 401(k) when you withdraw it, but if you wait until you are at retirement age there will be no penalty and you will pay income tax based upon whatever your income is at that time. Assuming you are making less per year, then the amount of tax you pay on this income will be much lower than what it would have been when you were at the peak of your career.
When working with those planning financial retirements one question keeps coming up. Should I consolidate all my accounts or keep them separate? Chances are that you have several different types of retirement accounts from different companies you’ve worked for along the way. This is not necessarily a bad thing but can be frustrating to try and keep track of.
Combining these funds can be a rather tricky endeavor as many of them are designed to only mate with like accounts. For this reason most 401 (k) plans can only be combined with another 401 (k) the same holds true for many other common retirement accounts including a 403 (b). The one type of account that can accept them all and consolidate them together is a rollover IRA.
Having only one account can simply so many aspects of your retirement that most people wonder why on earth they didn’t do this from the very beginning. There are many more benefits than mere ease that goes along with consolidating your accounts and eliminating those extraneous accounts. One of which is the fees that are often charged simply for having the account. These fees can add up over the course of several different accounts and consolidating them into one lone account will eliminate the fees of all the others.
One misconception that people have when it comes to rolling over their accounts is that they will lose their investment options. This is especially a misconception when it comes to a 401 (k) program as if you own a particular investment while it is a 401(k) you will still own the same investment when its within your IRA account.
In other words, a rollover IRA account offers the ultimate flexibility when it comes to your financial retirement needs. You can consolidate all your accounts into one, have all the information in one location and still enjoy the freedom that all the different accounts allowed you to experience in your investing. Diversity is a key ingredient when it comes to successful financial investing procedures.
If you are looking for the best when it comes to financial freedom for your retirement investments, you should take the first available opportunity to consolidate your investments into a rollover IRA. Of course you should discuss this with your financial advisor first in order to see if there is a better situation for your unique and personal needs however in many cases the convenience factor of this process is far too tempting to overlook unless there is a very big and specific reason for doing so.
Consolidation by and large is very much the way to go when it comes to your retirement funds. You do not however want to sacrifice the diversity of your plan in the process. You should keep your actual investments as diverse as possible in order to insure a well-balanced portfolio that is designed to maximize your profit potential while minimizing your risks.
The decision of whether or not to consolidate your many retirement accounts is as personal as your decision to wear brightly colored socks and ties. There is no absolute right or wrong answer and it quite literally comes down to a matter of preference. If you thrive in chaos then by all means keep five or six accounts going at any given time. If you need neat lines and nice rows that balance out in a glance then consolidation might be the very best thing you can do for your retirement fund.
Millions of Americans prepare for retirement with 401k plans. With these plans, employees contribute money through payroll deductions. In many cases, employers match. That money is invested and it continues to grow overtime. When used correctly, the individual is able to retire comfortably with the money invested, made, and saved. The keyword is saved. Those in financial distress often turn to their 401k plans and opt for an early withdrawal. It is a good idea? No.
When withdrawing money from a 401k plan, you are charged a penalty. This is 10% of the amount withdrawn. Although 10% is a relatively low figure, it is still money you lose and for no good reason. Moreover, you pullout from your investments. Overtime, they likely would have grown.
Since there are financial consequences to tapping into your 401k early, what are your alternatives?
Plan wisely. A 401k is a retirement savings plan. As you near retirement, you should aggressively put money in your account. Still, it is important to save money the traditional way. If you do not already have a savings account, get one. You have a set amount you contribute to your 401k plan each paycheck. Set the same plan for your savings account. In fact, most companies with direct deposit allow you to scatter your funds. Deposit some in your checking and some in your savings account.
Save money. Many individuals only believe those in debt need to save money. This is not true. Saving money benefits everyone. There are many ways to save money. Reduce your phone, internet, or telephone packages. Look for sales and use coupons at the grocery store. Another effective, yet simple approach is to save your change in a jar. Take all of the money you saved by creating a budget or limiting your expenses. Deposit into your savings account. This money can come in handy during an emergency. If you never use it, it is still there when you retire.
Opt for bank loans. For those with poor credit, this may not be an option. If you have good credit, apply for a loan. Personal loans are harder to get, as they are unsecured. With that said, financial lenders give them to those who need help paying medical bills, paying for costly car repairs and so forth. As for buying a new home, going to college, or buying a new car, there are specific loans for these. They are mortgages, student loans, and automobile loans. Apply.
If you are denied a bank loan, your next instinct is to move on to the next option. We will get to that in a minute. For now, why were you denied? It likely had to do with your credit. If you are indebt, work to repair this as soon as possible. Take a percentage of the money saved and apply towards overdue bills. You should never enter retirement indebt. Even if you are not planning to retire for 10 years, work on improving your credit now.
If you cannot get a bank loan and do not have a savings account with emergency cash on hand, you may consider tapping into your 401k. Before doing so, speak to your employer. Many allow their employees to take 401k loans. This is different from an early withdrawal. You are borrowing the money. As opposed to a 10% early withdrawal fee, you may only be charged a small $50 administrative fee. If you opt for a 401k loan, you must repay. It may sound nice to just take your money and run, but consider the consequences. You lose money. Aside from the 10% withdrawal fee, the money does not continue to grow with your investments.
Finally, be sure to speak with friends and family. If you only need a small amount of cash, such as one or two thousand dollars, someone you know may be able to help. Often times, you are able to payback these loans without interest. They are “off-the-record,” loans. Just know that you are not the only person facing financial difficulties in this struggling economy. Family members and friends you thought were once wealthy, may have tightened their budget too. Do not be offended if your request to borrow money is turned down.
With the current economic crisis on everyone’s mind, you may be wondering if you should withdraw money from your 401K. Experts recommend that you do not. They advise that contributions should continue based on the “buy low-sell high” theory.
What does this mean for you? Simply stated, right now most individuals may have incurred a severe loss in their 401K plans. But, considering that the stock market has dropped approximately 5000 points since the economic decline, your portfolio will no doubt increase with stocks, bonds, and mutual funds that can now be purchased at a very low rate.
If you withdraw funds from your 401K, the cumulative effect will result in your taking a double loss. First, by paying a penalty for early withdrawal – and second, by decreasing the amount of purchasing power you would have as a result of the stocks tumbling to their lowest rates.
You may withdraw funds from your 401K at age 59½. If you withdraw beforehand, however, you will incur a 10% penalty and pay tax on the amount distributed.
You do have another option. Since most economists believe we are headed for a recession, you can roll over your 401K into a Roth IRA or traditional IRA. If you decide to do so, here is some advice from the IRS:
Rollovers from your 401(k) plan. A rollover occurs when you receive a distribution of cash or other assets from one qualified retirement plan and contribute all or part of the distribution within 60 days to another qualified retirement plan or traditional IRA. This transaction is not taxable but it is reportable on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. and your federal tax return. You can roll over most distributions except for:
* A distribution that is one of a series of payments based on life expectancy or paid over a period of ten years or more
* A required minimum distribution
* A corrective distribution
* A hardship distribution
* Dividends on employer securities
Any taxable amount that is not rolled over must be included in income in the year you receive it. If the distribution is paid to you, you have 60 days from the date you receive it to roll it over. Any taxable distribution paid to you is subject to mandatory withholding of 20%, even if you intend to roll the distribution over later. If the distribution is rolled over, and you want to defer tax on the entire taxable portion, you will have to add funds from other sources equal to the amount withheld. You can choose to have your 401(k) plan transfer a distribution directly to another eligible plan or to an IRA. Under this option, no taxes are withheld.
You may borrow up to 50% of your vested account balance up to a maximum of $50,000. The loan must be repaid within 5 years, unless the loan is used to buy your main home. The loan repayments must be made in substantially level payments, at least quarterly, over the life of the loan.
However, if you cannot afford to pay back the loan, it is considered a distribution if you default on three consecutive payments and the funds withdrawn will be taxed.
In short, the answer is yes – absolutely. Here are the reasons why. Let’s assume you took a substantial hit to your 401K plan when the stock market plummeted approximately 5000 points.
The amount of stocks, bonds, mutual funds, and other holdings that your 401K provider continues to purchase at a very low price will eventually increase in price once the stock market rebounds. If you do not contribute, you will be losing out on the potential increase your overall portfolio will obtain.
The economic rule of thumb is to buy low and sell high. Now is therefore the best time to make substantial contributions to your 401K, especially if you are a young individual who has just entered the business world or if you are five to ten years from retirement. It’s a good idea to check with your 401K plan provider or employer to determine what the maximum contribution is and, if at all possible, whether you can meet that amount annually.
If you cannot afford to maximize your contributions, you can determine what percentage you can afford per paycheck so that at least you are contributing something to the plan. For example, let’s assume you can only contribute 5%. Take time to set a household budget and then determine how much you can afford to contribute to your 401K. Perhaps you can start with 5% and increase it by 1% each year, until you reach the maximum allowed.
A 401K is non-taxable except in an extreme case wherein you are financially strapped and need to withdraw all the money. In this case, you will be taxed for early distribution. There are other options available to you. If you need money for your child’s college tuition or to pay the mortgage, you can apply for a hardship distribution.
You can also apply for a loan of up to 50% of the total amount accumulated. However, it would have to be paid back in five years and if you default three consecutive months in a row, it will be considered a distribution and is therefore taxable.
While most economists estimate that the current economic crisis will last approximately 18 months or longer, it is advised that you seriously consider whether or not you want to utilize this money. Remember, the 401K provider will continue to increase the amount of equity in your plan now, and at a time when stocks are at their lowest, you can lose out in the long term if you stop contributing.
Having a 401K plan is an important of your financial future. Whether you stop contributing or not is up to you, but it is recommended that you contribute something every paycheck so that when the economy turns around, you will at least have some funds available to you in case of an emergency.
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