Employer sponsored savings plans can be a pain-free way to create a more financially secure retirement. The 401(k), 403(b) and the 457(b) are some of the most popular retirement savings plans offered by employers. Contributions are made on a tax-deferred basis, allowing employees to pay taxes on the funds in their accounts after they reach retirement status. Let’s take a look at how these plans can help you out with your finances in the future.
What do all the numbers mean?
The numerical identification refers to the Internal Revenue Service (IRS) tax code which establishes rules for administering the various types of plans. A 401(k) plan is for employees of for-profit companies that operate on a public or private basis. Employees of non-profit organizations invest in a 403(b) plan. The 457(b) is reserved for those employed by state and local government agencies.
How are funds invested?
After you enroll in a plan, a pre-determined amount is deducted from your paycheck and sent to a fund administrator for investing on your behalf. Your company may match your contribution which increases your investment. The administrator selects from an assortment of investment tools such as money market accounts, stocks, bonds and mutual funds. The distribution is made according to the level of risk you choose. People who are more than 10 years away from retirement may opt for high risk investments such as stocks which typically have a greater earning potential. If you expect to retire in a few years, you may want to choose a more secure portfolio with an emphasis on federal government bonds and money market accounts which offer a lower rate of return. The investment company is required to send you regular status reports.
Individual companies may have specific guidelines limiting contributions. The IRS has set a limit of $17,000 for retirement plans for 2012. Workers over the age of 49 can take advantage of the catch-up clause to make additional contributions up to $5,500. Although you do have access to your money, if funds are withdrawn before you reach the age of 591/2, you may have to pay a 10 percent penalty to the IRS. Taxes are always assessed when funds are withdrawn.
Is there a glitch?
An employer-sponsored retirement plan has many advantages, but there is also a flip side. Your funds are impacted by market fluctuations. Even a safe haven does not come with a guarantee. It is advisable to keep a close eye on portfolio performance so that you can make adjustments in the event of a downturn to lessen your potential loss.
Many employers have strict limits on contributions that can thwart an ambitious vision. Your goal may be to set aside 25 percent of your monthly income while your employer may have a 10 percent cap.
Finally, the ability to borrow against your savings can be tantalizing. However, stiff penalties are assessed if the loan is not paid back as stipulated. All funds must be repaid with interest to avoid being in default and possible forfeiture of the account. This feature can be a booby trap for those who are not excellent money managers.
Check with the office of human resources at your place of employment for complete details on available retirement plans.
Do you utilize any of these savings plans through your company? Tell us about it in the comments section below!
SOURCE: IRS, Retirement Made Simple
IMAGE: Courtesy of Scott On Money