Company 401K Plans
401K plans allow employees to make an election between receiving current compensation as cash or having part of it contributed to a profit sharing or stock bonus plan. These plans
are named after section 401(k) of the Internal Revenue Code. Besides employees making contributions by electing to have part of their salary contributed to the plan, employers
may contribute to a 401K plan through employer matching contributions or a profit sharing program.
For income tax purposes, employee and employer contributions are not considered salary for employees.
The contributions and earnings in a 401K plan grow tax-deferred (tax isn't due until distribution). An alternative to the traditional 401K is the Roth 401K in which income taxes are paid on the contributions but all distributions grow on a tax-deferred basis and no taxes are paid on withdrawals. The Roth provision was created effective January 1, 1998 as part of the Taxpayer Relief Act of 1997. Congress made the Roth option permanent in 2006.
A special kind of 401K Plan (the Individual 401K) is available for self-employed individuals and their spouses. These generally allow for much greater contributions that the often
uses SEP-IRA and offer additional benefits like borrowing against the value (for any purpose including real estate, college funding, etc.) and are both low cost and low administration
The general tax rules described below are the federal income tax rules as of January 1, 2007 and may be subject to exceptions. Always check your state (and local) income tax rules
on 401K plans. Finally, since tax laws may (and probably will) change from time to time, always check with your tax advisor before making major decisions regarding your 401K plan.
Employees may need to:
1. be at least
age 21, and
The term 'year of service' means at
least 1,000 hours of work.
2. have completed one year
of service with the employer
Employers can include more employees by reducing these requirements.
There are several yearly contribution limits. However, you are not required to
meet the contribution limits.
1. The employee pre-tax contribution limit may be up to $17,500
in the year 2013.
In addition, there are special rules if you own 5% or more of the company or
you are a highly compensated employee (e.g. compensation in 1999 over $80,000
affects an employee's contribution limit in the year 2000 and compensation in
2000 over $100,000 affects an employee's contribution limit in the year 2007).
2. The maximum amount of all contributions from you and your employer
and all other additions to your account cannot exceed the lesser of:
a. 25% of compensation, or
3. An employer can deduct up to 15% of the compensation of all plan
Vesting depends upon the type of contribution made to the 401(k) plan.
Employee contributions and the earnings from those contributions are 100% vested.
Your ownership of the employer contributions and the related earnings depends
upon the vesting period set up in the 401(k) plan.
Benefits of the 401K Plan
1. Employee pre-tax contributions can be as much as $17,500
Negatives of the 401K Plan
2. Employers usually match at least part of the employee contributions.
3. Contributions aren't considered part of an employee's salary for
income tax purposes.
4. Earnings and contributions grow tax-deferred without any reduction
for income tax each year.
5. Employee contributions and related earnings are 100% vested.
6. Special creditor protection may be available.
7. You may be able to delay the start of distributions if you continue
to work past age 70 ½.
1. Distributions of earnings and previously untaxed contributions
are taxed at ordinary income tax rates (from 15% to 39.6% for federal tax plus
state tax as of January 1, 2007). Benefits of the 401K Plan
2. Employer contributions and related earnings may not be vested or
fully vested for a period of years. Benefits of the 401K Plan
3. There is a penalty for early withdrawal unless an exception applies
(see section below on exceptions to early withdrawal penalty)
Legal and tax advice is useful when determining how to complete beneficiary designations.
Properly completed designations can help save estate (death) tax, avoid probate,
allow better income tax opportunities and avoid creditor claims on retirement
Extra care needs to be taken in naming trusts as a beneficiary of most retirement
assets in case of a death. Sometimes, naming trusts as a beneficiary can trigger
income tax sooner than it would otherwise be owed and reduce the amount ultimately
shielded from death tax.
Note that many plans require the participant's spouse to be the beneficiary,
unless the spouse provides written permission for another beneficieary to be
Retirement plans and accounts may have special creditor protection under federal
and/or state laws. Different types of plans and accounts may have varying degrees
of protection. State protection rules may also vary from state to state.
If you convert from one type of plan to another (e.g., from a traditional IRA
to a Roth IRA), you may be changing how much protection you have. This may be
also be the case if you move to another new state where the new state rules are
Consulting with an attorney for guidance on the creditor protection issue may
Estate and Death Taxes
Retirement assets are added to your other assets and may be subject to federal
and/or state death (estate) tax. It depends upon the size of your overall estate
and the estate planning done for you. Consult with your advisor about ways to
defer or avoid estate tax.
For more information:
If you'd like more information about how diversified investment advisors can help you achieve your financial objectives through personalized wealth or retirement and risk management strategies, please contact us. We welcome the opportunity to discuss your unique needs and how we may best meet them.
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Charles M. Bloom, Registered Principal offers securities
and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.
The information contained in this web site is neither an offer nor solicitation of any security or service.