A 401(k) is a retirement savings plan that is offered by companies to their employees. Employees can save a small percentage of money from their paychecks before taxes are deducted. 401k plans are beneficial in helping people save for the future.If you want to maintain your standard of living after retirement, then you need to start saving money now as part of your retirement planning. A 401(k) is just one of the effective ways through which you can do that. There are two types of 401(k); one is a defined benefit plan and the other is a defined contribution plan.
Defined Benefit Plans
A defined benefit plan, as the name suggests, is a plan in which all the benefits that you are offered are defined. It is often referred to as a pension plan. The workplace or employer offers to pay a specified amount of money to people who retire, given that they meet certain criteria. This plan offers monthly benefits to retirees for the rest of their lives. The benefits usually depend on the services and salary of the individual. It is a good plan as employees know how much they will be getting beforehand.
Defined Contribution Plans
A defined contribution plan on the other hand defines the contributions that the employee will make towards his retirement instead of the benefits. Since the benefits are not defined, an employee cannot know the outcome in advance, as it all depends on the amount the employee is able to contribute over the course of their employment. This type of 401(k) plan is the most common type of retirement plan offered these days. Most employers will match their employees contributions up to a certain percentage, which is referred to as the employer match. Ultimately, with defined contribution plans you can control how your money is invested in your 401(k). It is recommended that you put as much money into your 401(k) as you can without affecting your current way of living.
Here are some quick 401(k) facts to consider:
- Any business can have a 401(k) plan, be it a proprietorship, partnership, corporation, self-employment, etc.
- The workplace can restrict employees from being eligible for the plan if they have worked for less than a year, if they’re part-time workers, non-US citizens, union members, etc.
- Participants of 50 years of age or older can make “catch-up” contributions of $6,000 per year.
- Any withdrawals before the age of 59 1/2 will have a 10% penalty tax applied to it.
- You can make a vesting schedule for the contributions made by the company with certain guidelines.
- The employer has no obligation to contribute towards an employee’s 401(k) unless the plan is considered top heavy.
- You may be able make all your savings and contributions online.
- You can invest the money that is saved in your 401(k).
- There is no federal income tax applied to the money you have saved up until a distribution is made.
- Contribution to your 401(k) can come from employee salary reduction, the employer, or both.
Filing a 401(k)
Most companies let you file for a 401(k) as soon as you join the company. You can increase or decrease your contributions at any time. You also need to select a beneficiary who will inherit the money when you die. If you are married, then your spouse is automatically appointed the beneficiary. It is important to work with your Human Resources department at your employer to fully understand your 401(k) options.
Want to more about retirement options? Check out this video from KIMT News 3, featuring our Lender Development Manager, Troy Brenhaug.