What is a 401k Plan?
A 401(k) plan is a certain type of Profit Sharing Plan which an employer operates for the benefit of himself and his employees. Participants are allowed to defer a portion of their salary into the plan to save towards their retirement. In addition, the employer may “match” a percentage of the amount deferred.
Why does it pay to take a cut in salary?
Contributions which you decide to deposit into the plan are made from your “before tax” dollars. For example, if you make $25,000 a year and decide to put $1,000 in the plan, you would pay taxes on only $24,000. The $1,000 accumulates tax free in the plan until the time you take it out.
Where is my money invested?
Usually the employer acts as trustee to the plan, and will invest the money for you. In some 401(k) plans, you may have the option of selecting from an array of different investment vehicles that the trustee offers. These options generally range from conservative to middle-risk, and on up to higher risk elements.
How much can I contribute each year?
A participant can contribute a maximum of $16,500 for 2011, $17,000 for 2012, (up to 100% of your income) to the plan in a single year. This is usually stated as a percentage of compensation or fixed dollar amount per pay period. In addition to this amount, the employer may choose to contribute to the plan as well. Also, if you are over age 50, you may make an additional “catch-up” contribution of $5,500 for 2011 and 2012.
Can I change the amount I'm contributing to the plan?
Yes, a participant can change the amount he/she contributes to the plan at any time. However, if you are allowed to make individual investment elections, changes to your investment choices may be limited to a few times a year.
How do I begin participating?
When you have met all the requirements for eligibility, your employer will notify you. Once you have elected to participate, your employer will begin taking Salary Reduction contributions from your gross pay. General eligibility requirements may include being over age 21, employed for at least 12 months, and working at least 1000 hours per year.
When can I take my money out of the plan?
The plan will distribute your money to you when you separate from service, retire, die, or become disabled, whichever occurs first. There are several options to choose from on the form of payment you will receive (i.e. annuity, lump sum, rollover, etc.) Unless your employment status changes in one of the ways listed above, access to your money in the plan is limited. Prior to age 59 1/2, distributions are limited to “financial hardships”, and a 10% early withdrawal tax is imposed by the IRS. A financial hardship results from an “accident or sickness of a participant or his dependents, or financial hardship resulting from the establishing or preserving of the home in which the Participant resides.” Another way that you may be able to access some of the money in your account is through a plan loan. However, not all plans provide for hardship withdrawals or loans. You should check with your plan trustee for more information about availability in your plan.
Is my money paid out if I stop contributing to the plan?
No. 401(k) plans may only make distributions upon stated events: separation from service, death, disability, retirement or hardship. A separation from service means that an employee-employer relationship has been completely severed. A change in work hours from full-time to part-time would not qualify. In one situation, an employee was told that she could not be rehired as a part-time employee after retirement if she took a distribution from the plan. In a suit filed by the employee, the IRS sided with the employer. Distribution could not be made to an employee without risking disqualification of the plan vehicle.
I've terminated my employment, so when do I get my money?
Generally, distributions may be made at the participant’s election within a reasonable period following the distribution determination date. This date is usually the Valuation date following a break in service. Assuming your plan is based on a calendar year, distribution would take place after the valuation is completed at the end of the year. Since the plan sponsor has 10 1/2 months to file the annual report with IRS, the valuation may not be completed until the following October. So your distribution can take as much as nearly two years from your actual date of termination.
Two years?!?! But when my friend quit his job, they paid him out on the spot!
That was a worst-case scenario. All plans are written and designed differently. (See disclaimer at bottom of page.) In a plan where individuals are allowed to make their own investment choices and individually segregated accounts are maintained, payout certainly would be possible much sooner. Just don’t get your hopes up. And it could be worse; many more traditional pension plans require you to leave your money in them you actually reach retirement age. This is not commonly found in today’s 401(k) market; however, it is possible.
How is my money taxed when I take it out?
Money taken out of a plan is taxed as ordinary income in the year received. Sometimes it may qualify for special tax treatment or may be rolled over to an Individual Retirement Account. Your employer will explain these options to you whenever a distribution is made.
Is there any necessary reporting that I have to do with the IRS?
No. The plan administrator is required to submit an annual report to the IRS for the plan, but the individual participants are not required to do anything until they receive benefits. Form 1099-R will be provided to you if a distribution is made to you from the plan.
What happens to my money if the company discontinues the plan?
If the plan is terminated, all accounts become 100% vested and the participants will receive their entire account balance. If the company were to close its doors, the money in the plan is protected from creditors by ERISA law.
What is 'vesting'?
Vesting describes the percentage of ownership that you have toward the money that your employer puts into the plan for you. The longer you are a participant in the plan, the higher the percentage of ownership you have in the employer funded accounts. Vesting applies only to money contributed to the plan by your employer. All money that is deducted from your salary and deposited to the plan is always 100% vested. A common vesting schedule would provide 0% vesting, or rights, the first year that you are a participant in a plan, then 20% each following year, until after 6 years you would be 100% vested in all employer funded accounts.
How often will I receive an account statement?
Individual participant statements are required to be produced only once a year. The plan sponsor must file an annual report with IRS as of the close of the plan year, and the participant statements are usually prepared at the same time. The annual report must be filed within 10 1/2 months of the close of the year. If your plan provides for individual investment choices, you may receive statements more often. Also, some plans provide for semi-annual or quarterly evaluations and statements. Check with your employer for more information about your specific plan.
Disclaimer: The above information is a brief description of some frequently asked questions and refers to general qualified plan guidelines, and is not geared specifically toward any particular plan. This document is not meant to interpret or change the provisions of your plan. A copy of your plan is on file at your employer’s office and may be requested to be read by you, your beneficiaries or your legal representatives at any reasonable time. If you have any questions regarding the above information, you should contact your employer. If any discrepancies exist between the above information and the actual provisions of the plan, the plan shall govern.