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What are 401ks

401(k) plans are retirement vehicles that allow employees to save for their own retirement. This type of plan was named for section 401(k) of the Internal Revenue Code, which permits employees of qualifying companies to set aside tax-deferred funds. We at 401k Forum are proud to have the person who first developed the 401(k) plan, Ted Benna, as a member of our Board of Directors. By making this change to the Code in 1978, the government opened the door for more efficient retirement planning for all Americans. It's no exaggeration to say the 401(k) plan is the most important national retirement effort since Social Security was introduced in the 1930s.

How It Works
The 401(k) mechanism is fairly simple. The plan is set up by your employer as a defined contribution retirement arrangement. That means you are the one who pays into the plan, although your employer and the plan provider who offers your 401(k) do just about all the work.

Your 401(k) contribution is automatically deducted from your paycheck each pay period. This money is taken out and invested before your paycheck is taxed. After you have decided what percentage you want deducted from your check, and how you want to invest it, your work is pretty much done.

Once the money is deducted from your paycheck, you can't spend it, but it is yours. It grows in your personal 401(k) account. Although you can withdraw the money for certain emergencies or in some cases borrow against your investment, the money is intended to stay in your account until you are at least 59 1/2.

While the investment is growing in your 401(k) account, you do not pay any taxes on it. When you withdraw the money at retirement, you pay taxes on the amount you withdraw from your account (so you pay taxes little by little instead of being hit with one big bill).

What's a 401K and How Does it Work?

401(k) plans are retirement vehicles that allow employees to save for their own retirement. This type of plan was named for section 401(k) of the Internal Revenue Code, which permits employees of qualifying companies to set aside tax-deferred funds. We at 401k Forum are proud to have the person who first developed the 401(k) plan, Ted Benna, as a member of our Board of Directors. By making this change to the Code in 1978, the government opened the door for more efficient retirement planning for all Americans. It's no exaggeration to say the 401(k) plan is the most important national retirement effort since Social Security was introduced in the 1930s.

How It Works

The 401(k) mechanism is fairly simple. The plan is set up by your employer as a defined contribution retirement arrangement. That means you are the one who pays into the plan, although your employer and the plan provider who offers your 401(k) do just about all the work.

Your 401(k) contribution is automatically deducted from your paycheck each pay period. This money is taken out and invested before your paycheck is taxed. After you have decided what percentage you want deducted from your check, and how you want to invest it, your work is pretty much done.

Leaving Your Job? Keep Your Retirement Funds Safe with a 401(k)-IRA Rollover

Three years ago, R. Boeding, retired from his 35-year job with an electric company. His employer gave him a choice: take his retirement fund money ($450,000) all at once or let the company pay out fixed amounts over time from his account.

If he chose the latter and died early, his wife would only get half the amount.

"It was a no-brainer," said Boeding, who was 55 when he retired. He wanted the money so he took the lump sum, which he then rolled into an IRA.

He faced the question many retirees and job hoppers face: do I leave my money in the 401(k) or other employer-sponsored plan, cash out, or roll it into an IRA? That's a big decision and making the wrong one can be costly.

You might want to consider rolling your money into an IRA because that will enable you to continue to keep your money sheltered from tax as well as continuously invested. Here's the low-down on when and how you can take the money, and why you might want to.

When To Roll Your 401(k) Into An IRA
You can roll your 401(k) money into an IRA only in certain circumstances. Those are: when you quit or are fired from your job, or retire. You can't roll over your 401(k) funds into an IRA while you are still working for the same employer just because you don't like the investment choices in your plan.

What are the 401K Contribution limits in 2007

Discover 401k Contribution Limits and What They Mean
It is important to keep your eyes on what amount you are allowed to contribute to your 401k account each year. There are two different 401k contribution limits you need to be aware of. The government sets the limit allowable and the employer sets their own 401k limits for their employees.

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U.S. Government Imposed 401k Contribution Limit Guidelines
Lucky for us, the government is beginning to understand the importance of saving for retirement and has started increasing the limits each year to help people save so they don’t have to rely on Social Security (which may not exist by the time I retire). Here are the current IRS 401k Contribution limits (you will also find information on catch up contributions):

Employer Imposed 401k Contribution Limit Guidelines
Employers can choose their own maximum limit.

401(k) Substitutes for Small Business Owners… part 3

Complicated Keogh Plans

A less popular retirement plan available to small businesses and self-employed workers is the Keogh or HR-10 plan. The reason it's less popular, according to financial planners interviewed for this article, is that a Keogh requires more complicated paperwork than SEP or SIMPLE plans because it is a qualified plan.

With a Keogh plan, the small business owner or self-employed person needs to set up a trust account where all employer and employee contributions are deposited. The plan document stipulates how the contributions may be invested.

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In addition to needing a trust and a plan document, the business owner needs to file an annual report (Form 5500) to the IRS. Further, a small business owner offering a qualified plan must make contributions each year regardless of the health of the business.

A Keogh plan can be set up as a profit-sharing plan, a money-purchase plan or a combination of the two.

While employees may make after-tax contributions to an employer-sponsored Keogh plan, the primary contribution comes from the employer. The IRS requires employers to contribute the same amount for each employee as for themselves.

Fortunately, the IRS has made a paperwork concession for a one-participant plan. In this case, if the plan covers only you and your spouse, and/or one or more partners and their spouses in a business arrangement, you can file a short (two-to-three page) Form 5500EZ.

The biggest advantage of a Keogh plan is the amount you can save in it — up to 25 percent of pay, not to exceed $35,000 a year. "The Keogh is for top-end individuals. The more money you have (to save), the better the Keogh is for you," commented Lee.

Another advantage is that participants can take a loan from their Keogh plan.

Because a Keogh is considered a qualified plan, withdrawal and distribution rules for 401(k) plans also apply to Keogh plans.

For more details on how to set up a Keogh plan, read IRS Publication 560.

IRAs: Roth and Traditional

If you're just beginning a business and have little extra money to set aside for retirement, can't afford to offer any retirement benefits to employees, or are a freelancer and the options above don't interest you, you might want to consider opening a Roth IRA or traditional IRA.

The drawback to these tools is their low annual contribution limits of only $2,000.

With a traditional IRA, your contributions are made before taxes. At retirement, you may withdraw money from the plan, but at that point you must pay taxes on the original contribution and any profits earned.

With a Roth IRA, your contributions are made after taxes. When you withdraw money at retirement, you won't have to pay any tax on the profits the account earned providing you follow the rules.

Where to Find a Provider

If you're a small business owner, you likely won't be able to interest the large 401(k) plan providers in servicing your small account. Yet, most of the other plans discussed in this article can be set up through your local bank, a certified financial planner or an accountant.

401(k) Substitutes for Small Business Owners… part 2

Simple SEP Plans 

The Simplified Employee Pension (SEP) is similar to profit-sharing and pension plans in that all contributions come from the employer. An advantage of this plan is that contribution limits are much higher than for SIMPLE plans.

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Ed Slott, a CPA and editor of Ed Slott's IRA Advisor newsletter, chose to offer a SEP to his staff of two. "It's the best plan for employees," he said. "I have great employees. I want to retain them and motivate them. The plan is a great ... incentive to keep a great crew."

SEP contribution rules, however, are a little tricky. As the employer, if you contribute a percentage of your salary to a SEP, you must also contribute the same percentage of your employees' salaries into the SEP for them. For this reason, SEPs tend to be favored by small businesses with only a handful of employees, Slott said.

The contribution limit formula for a SEP plan is as follows: The contributions can't be more than 15 percent of an employee's compensation or $30,000, whichever is less. That said, employers can't include salary above $170,000 in a year in calculating an employee's contribution limit. Fifteen percent of $170,000 is $25,500.

If you did your math in the last paragraph and wondered, "how is this possible?" then you need to know that in order to save a total of $30,000, your employer must have some kind of additional plan. One way an employer could boost the deferral to $30,000 would be to combine the SEP with a money-purchase plan, Slott said. A money-purchase plan is a little like a traditional pension plan in that the employer contributes to an employee's account based on that person's income and years of service.

A SEP plan may be set up anytime during the calendar year. Business owners can even wait to open a SEP for a tax year until they file their tax return on April 15 of the following calendar year.

Employees aren't permitted to contribute to SEP plans unless they are the sole employee (in other words, the business owner). Employee salary reductions are permitted, however, in special SEP plans called SARSEP plans, which aren't covered in this article.

One reason many small business owners choose SEP and SIMPLE plans is that contributions don't have to be made every year. If your business has a bad year, you can choose to discontinue the contributions temporarily.

Withdrawal rules for SEPs are similar to those for IRAs.

Read a breakdown of small employer retirement plan features.

401(k) Substitutes for Small Business Owners… part 1

Despite all the hype surrounding 401(k)s, their cost and administrative requirements often make them a no-go for small business owners. What's more, they're not even available to self-employed individuals.

But, that shouldn't stop small business folks from benefiting from the tax advantages of tax-deferred plans. Over the past few years, Congress has created a new batch of simple (literally and figuratively) plans ideally suited for small businesses.

Now, small businesses can offer employees benefits comparable to big businesses.

In fact Blackstocks/ShareBuilder has a great 401K plan for small businesses.

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Finding the most effective and least burdensome tax-deferred retirement saving plan requires some research because there is no one-size-fits-all option.

It's worth the effort, though, and here's why: A small business owner or self-employed individual can save more tax-deferred money in these plans than in almost any other savings vehicle. While that's a big advantage, retirement plans do have some tradeoffs. The most significant is that in exchange for lower paperwork requirements, the employer is required to make contributions to the plan on behalf of the employee.

The first step in choosing a retirement savings vehicle is to define your status. Are you self-employed or a small business owner?

The distinction is not always obvious. A self-employed individual may or may not have employees, while small business owners may or may not be incorporated and may have no employees or only up to 100. This panoply of variations often leaves these folks scratching their heads and wondering what's the best tool to use.

A gen Xer launching a new dot-com may have different needs than a lawyer hanging out her own shingle. You must consider:

The amount of time and money you have to spend on a retirement plan;
Whether you have employees;
How much you value your employees; and
"Where you are in your business cycle," said Dee Lee, author of the book Let's Talk Money.

Stay in Your Protective Shell.... part1

You're changing jobs and you've got several thousand dollars in your former employer's 401(k) plan. What to do?

It looks like that money could just about cover credit card bills you've built up. Should you wipe the slate clean by paying those bills, and start fresh with a new job and outlook? "No! No! No!," say retirement experts.

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With people reportedly changing jobs about every five years or so, on average, it's apparent that many workers, at one time or another, are going to have to decide what to do with their 401(k) money when they change jobs.

Regrettably, most are not making the smart choice.

Financial planners are united on this one point: Leave your retirement funds, no matter how small, within tax-deferred savings accounts.

Yet, this advice is falling on deaf ears. A recent study shows American workers are cashing out of their 401(k) plans at near-record rates.

Sixty-eight percent of employees opted to take a cash payout from their 401(k) plan when changing jobs, according to a Hewitt Associates study. Only one-third of workers roll their balances into an IRA or a new employer's plan.

Defaulting on 401(K) Loan Can Lead to Disastrous Results

Raise your hand if you've defaulted on a 401(k) loan.

My hand is up. I couldn't help it. I moved abruptly from one state to another and became a caregiver. I had two choices. Repay the loan - or live and eat. Wasn't that a no-brainer?

According to the Richmond Time, here's the reality: A 401(k) loan can turn into a disaster. For those of you who are on the brink of defaulting on one and can't see a way out, here's what life can be like afterward - and here's how the Internal Revenue Service can get away with tacking on enough penalties and interest to make a predatory lender look like Little Miss Muffett.

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First, though, if you have an outstanding loan, you are not alone. In a 1998 study of 7.9 million 401(k) plan participants nationwide, 16 percent of employees eligible for loans had one or more outstanding, according to the Employee Benefits Research Institute in Washington. The average unpaid balance was $6,717.

But those loans can easily turn into a nightmare. Say you take out a loan for $10,000 to pay for whatever. Your employer deducts the payments, and life is good. Later, though, you leave the job. According to the law, 401(k) loans become due in full when the borrower leaves the job.

Now you might be in trouble. If you don't repay the loan, your employer sends out a 1099 statement to the IRS. The IRS adds the unpaid loan amount to the rest of your income for that year and hits you with a fat tax bill. Then, unless you're age 59 1/2 or older, it slaps you with a 10 percent early withdrawal penalty.

401(k) Substitutes for Small Business Owners Part 2

Part #2:

"I have great employees. I want to retain them and motivate them. The (SEP) plan is a great ... incentive to keep a great crew."
— Ed Slott, CPA and editor of the IRA Advisor newsletter.
The contribution limit formula for a SEP plan is as follows: The contributions can't be more than 15 percent of an employee's compensation or $30,000, whichever is less. That said, employers can't include salary above $170,000 in a year in calculating an employee's contribution limit. Fifteen percent of $170,000 is $25,500.

If you did your math in the last paragraph and wondered, "how is this possible?" then you need to know that in order to save a total of $30,000, your employer must have some kind of additional plan. One way an employer could boost the deferral to $30,000 would be to combine the SEP with a money-purchase plan, Slott said. A money-purchase plan is a little like a traditional pension plan in that the employer contributes to an employee's account based on that person's income and years of service.

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A SEP plan may be set up anytime during the calendar year. Business owners can even wait to open a SEP for a tax year until they file their tax return on April 15 of the following calendar year.

Employees aren't permitted to contribute to SEP plans unless they are the sole employee (in other words, the business owner). Employee salary reductions are permitted, however, in special SEP plans called SARSEP plans, which aren't covered in this article.