My Financial Tips

401 (k) plans are the most popular and unique retirement-cum-investment plans around the world. Classified under the category of defined contribution plans, 401 (k) plans are primarily initiated by employers with the objective of safeguarding the financial uncertainty of an employee at the time of retirement.

In case of a 401(k) plan, the employee is required to contribute a certain percentage of his monthly salary towards payment of premium. According to IRS, one can contribute up to $15,000 per year towards the plan. In certain companies, even the employer makes an equal contribution towards an employee’s 401(k) plan. This money is then invested in mutual funds, stocks, money market accounts and bonds. These investments are made as per the specifications given by the employee.

It is the responsibility of employers to secure the future of their employees after retirement. In this regard, 401 (k) plans are extremely beneficial. Some of the benefits that these plans offer to employers include:

1.    Good strategy to attract potential employees from other companies by providing better incentives and benefits as a part of 401(k) plans
2.    Ensuring better growth and increased revenues by enticing employees with higher contribution towards 401 (k) plans depending on their performance
3.    Also, 401 (k) plans are the most economical means of retaining employees.
4.    Any contributions made towards 401(k) plans can be categorized by employers under tax-deductible expenses

In case of employees, benefits of 401(k) plans include getting free money from the employer, better financial security at the time of retirement and lower taxable income. This is because contributions made towards the plan are deducted from an employee’s salary even before federal tax is calculated. One can accumulate savings without thinking about deposits. 401(k) plans even provide employee with the opportunity to defer their tax payments on earnings made on 401(k) investments until retirement. In this way, people can save hundreds of dollars as several states don’t collect income tax for retirees. Even if a state collects, retirees are placed in a lower tax bracket.

In any case, it is important to have a proper planning in order to gain maximum benefits from a 401 (K) plan. Before investing, one should know about different types of 401(k) plans including their advantages and disadvantages. Below mentioned are some of these plans.

1.    Traditional 401(k) Plans: In these plans, taxable income of the employer is calculated after deducting the contributions made towards 401 (k) plans. In this way, one can save more and pay less tax. Disadvantage of these plans is that the withdrawals are taxable as per the existing income-tax norms of the state. These plans work better for employees working in states where income tax rates are low for retired people. However, these plans are not good for retirees preferring part-time jobs after retirements. Since earnings are taxable, such people have the risk of getting into higher tax bracket when the regular income from employment is combined with the income from a 401 (k) plan.

2.    Roth 401 (k) Plans: In these plans, the entire monthly earnings of the employer are calculated as taxable income. Contributions to the plan are made on an after-tax basis. These plans are beneficial because there is no tax on contributions nor the employee is required to pay any tax on earnings. Another advantage of these plans is that any amount that has been withdrawn due to emergency purposes is non-taxable. Also, these plans are highly beneficial for people planning to work after retirement.  However, it is important for a person to hold an account for at least five years.

Two basic parameters one must always consider while selecting a 401(k) plan include the income tax rate after retirement and the net returns on investment.