Frequently Asked Questions
What is a 401k plan?
A 401(k) plan is a retirement savings plan that is funded by employee contributions and (often) matching contributions from the employer. The major attraction of these plans is that the contributions are taken from pre-tax salary, and the funds grow tax-free until withdrawn. Also, the plans are (to some extent) self-directed, and they are portable; more about both topics later. Both for-profit and many types of tax-exempt organizations can establish these plans for their employees.
How does a 401K work?
If your company offers a 401k retirement plan, you are given the option of selecting the funds you choose to invest in from a list of funds provided in the 401k. Your company will provide you with a list of the funds they use for their plan and give you the opportunity to decide which you want to invest in and the percentage to invest. Your employee contribution will automatically be deducted from your pay check before taxes. Each employee can contribute up to a certain percentage of their pay into a 401k and some employers will match a percentage of your contributions. Your contributions along with any matched contributions are then invested into your selected funds. These funds will grow without being taxed and can be withdrawn when you reach the age 59 ½. At this time, you must pay income tax on the withdrawn funds. There are ways you can withdraw your funds before reaching the age 59 ½ but these withdrawals usually require a penalty along with payment of taxes.
What can I do to repair my declining 401k balance?
The first thing you might do is to look closely at how you are investing. If you're investing heavily in your employer's company stock, you should reduce this amount and diversify your investments. Adjust your contributions to make the most of the new contribution limits. Each year you can contribute the maximum tax-deferred amount to your 401k. This year, that amount is $11,000 plus an additional $1000 if you're age 50 or older. You can also make additional, nontax-deferred contributions of the lesser of $35,000 or 25% of your yearly income. Your age and your company's plan policy will be deciding factors in your strategy in repairing your 401k balance. Younger persons will have longer to rebuild their retirement plan than those who are 50 or over.
How should a 401k be balanced?
Money magazine has an excellent set of charts for 401k allocations in its September Special Report. The suggested allocations at three life stages are:
Aggressive--for those with 35 or more years until retirement
- 50%--large cap stocks
- 15%--mid cap stocks
- 15%--bonds
- 10%--small cap stocks
- 10%--international stocks
Moderate--for those with 20 years until retirement
- 35%--large cap stocks
- 35%--bonds
- 10%--mid cap stocks
- 10%--small cap stocks
- 10%--international stocks
Conservative--for those within 10 years of retirement
- 40%--bonds
- 30%--large cap stocks
- 10%--mid cap stocks
- 10%--international stocks
- 10%--cash
How will my 401k account affect my Social Security Benefits?
Your 401k account will have no effect on the amount of Social Security benefits you will be able to receive. However, it is important to realize that Social Security is not intended to provide for your entire retirement, but is meant to serve as a supplement to other income sources. For example, if your current income is $30,000 per year, the benefit you receive from Social Security will be approximately 40% of this, or $12,000 per year. This percentage varies according to your income. Hence, if you'd like to maintain the same standard of living you had while you were working, you do not want to rely on Social Security to be your only source of income after retirement.
What information is my employer required to provide me regarding my 401k?
Legally, all a participant is required to receive is a Summary Plan Description, a Summary Annual Report and an annual statement. You might not receive a prospectus for every fund offered in the plan, but if your company's stock is offered in the plan you must receive a prospectus (or prospectus substitute) for that. Luckily for participants, most plan sponsors provide participants a lot more information than they're required to. Keep in mind too that often if you need more information all you have to do is ask.
When can I begin to participate?
That depends on the rules of your specific plan. Many companies require new employees to complete six months or even up to a year of service before they're eligible to participate. Some companies also require employees to be at least 21 years old to participate.
Ask your company's Human Resources Department or Benefits Representative for information on your plan.
What happens to my account if the company I work for goes bankrupt?
All the contributions made to a 401k account are held in trust by a custodian separate from the company sponsoring the plan, meaning that your employer does not have access to any of the money that is contributed to your 401k. In other words, regardless of whether your employer goes bankrupt or is bought by another company, the vested amount of money in your account is always yours.
How does my 401k plan help me?
Your 401k plan helps you to start and stick with regular investing. Your contributions are automatically deducted from your salary before you receive your check. Since the money is deducted from your gross income, you will have lower taxable income, which means you will pay less in annual taxes. You couldn't ask for a simpler way to save!
The money you save will accumulate on a tax-deferred basis. This means you pay no Federal or State taxes on your contributions or investment earnings until you start withdrawing money from the plan. The benefit of a tax deferred account is that your dollars accumulate more quickly because your earnings are exempt from current taxation.
