Section 401(k) Retirement Plans
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Welcome
Editorial Calendar
Topic of the Week
Teaching 401(k) plans
Learning Activity
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I. Welcome
Again, welcome to a new year of financial lessons
and thank you for being a subscriber.
Tim Liptrap,
Vice President, Education and Development
Email: tliptrap@101financiallessons.com
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II. Editorial Calendar
-
529 Plans
-
Costs of maintaining a car
-
Automobile Insurance
-
Life Insurance
-
25 Health Insurance
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III. Topic of the Week
Section 401(k) Retirement Plans
What is commonly referred to as a 401(k) or 401(k)
plan is the IRS section of rules that govern retirement
plans - section 401, paragraph (k).
A section 401(k) retirement is an employer based
retirement plan, in which an employee (with earned income)
can elect to save a portion of their earnings (pre-tax), in a
special account used for retirement.
Section 401(k) retirement plans have many of the same
benefits and stipulations of an Individual Retirement
Account (IRA) including:
-
Investment monies grow tax-deferred for years. You
are only taxed on the money when you withdraw it, you
do not pay any taxes on the money on an annual basis.
-
If you take a distribution before 59 1/2 years of age, a
10 % penalty plus tax will be assessed (certain
exceptions apply).
-
An individual must start taking distributions by 70 1/2
years of age.
-
Monies are invested in Mutual Funds and Money Market
accounts.
Investment Options
In contrast to an IRA, a 401(k) plan is an employer-based plan
that is limited in the amount of investment options that are
available. In an IRA, a person may invest in thousands of different
mutual funds or stocks. Whereas, in a 401(k) plan, an employee
may only be able to choose between 7 - 15 funds.
The corporation's executives will choose the Mutual Fund Company
and the funds that are made available to the employees for
investments.
Benefits to the Employee and Corporations
The benefit to contributing to a 401(k) plan is that many
employers will make matching contributions to your account,
with either cash or corporate stock. As an example, for
each dollar the employee invests, a corporation may invest
$.50 (matching contribution). Thus, the employee has $1.50
earning money for them, rather than just a dollar. This is an
automatic 50% return on your investment.
Corporations make matching contributions to employee accounts
for many reasons, including:
-
Method to encourage employees to invest in their own
retirement -
Financial reward for a job well done
-
Retention technique
-
Recruitment benefit
-
Tax benefit for the corporation.
By federal law, if a corporation offers to match one
employee's contribution, they must make an offer to
all employees.
Contribution Limits
In 2002, the maximum amount that a person may
contribute (pre-tax) to a 401(k) plan was $11,000. If
you are 50 years or older, you are allowed to make an
additional $1,000 "catch-up" payment in 2002, bringing
your contribution total to $12,000.
From 2002 through 2008
, standard 401(k) contributions
and "catch-up" amounts for individuals 50 years or older,
will increase on a sliding scale. See chart below:
|
Year |
Standard Contribution |
50 years plus |
|
2002 |
$11,000 |
$12,000 |
|
2003 |
$12,000 |
$14,000 |
|
2004 |
$13,000 |
$16,000 |
|
2005 |
$14,000 |
$18,000 |
|
2008 |
$15,000 |
$20,000 |
Rollover Provisions
401(k) plans can be rolled over directly into other
401(k) plans, 403(b) plans or IRAs.
As a result of the Tax Relief Act of 2001, individuals
are now eligible roll over there 457 and 403(b) plans
(retirement plans for non-profit organizations and
school systems) directly to a 401(k) plan. This
allows a teacher to roll over their retirement plan
into a private corporation's, if they switch jobs.
Withdrawals
In section 401(k) plans, distributions can begin at
59 1/2 years of age, but is required by age 70 1/2 years.
Penalties may apply in monies are withdrawn earlier
than age 59 1/2.
Loans and Hardships
Unlike IRAs, a 401(k) plan may allow you to borrow
money against your balance. However, a 401(k) plan
administrator may allow you to borrow up to 50% of the
value of your 401(k). You must pay back the loan before
receiving any distributions and you may not be able
to contribute to your 401(k) until the loan is paid in full.
Hardship withdrawals may be made in instances such as:
sudden disabilities, certain medical expenses, college
education expenses and the purchase of a new home.
Many times, a 401(k) plan administrator will allow you
to borrow up to 50%
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IV. Teaching the Tax Deferred Income
Understanding the concept of 401(k), IRA and other
tax deferred retirement accounts is very important.
Teaching a student, who may not have an income, the
concept of saving money for a retirement account can
be difficult, but they need to understand this before
their first job.
We recommend having a discussion with your children to
explain the benefits of a 401(k) plan.
Talking Points for Discussion
-
Investing early in life offers more money at retirement,
because of the benefit of time. The more years you have
retirement money invested, the more money you will earn
due to the compounding effects.
-
If your company offers a matching program, it would be
wise to participate in at least a minimum amount to receive
a match, otherwise you are losing out on the opportunity
to earn "free" money.
-
Your taxable income is determined after subtracting your
gross contributions to a retirement account. (I.e. By
investing a percentage or your income into a retirement
plan (pre-tax), you will reduce the amount of your taxable
income. Thus, you will pay less in taxes now, and save money
for the future.)
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V. Learning Activity
Goal:
To show children the benefit of saving money using
a tax-deferred account.
Skills Exercised:
Mathematical Calculations
Problem Solving
Internet
Word Problems:
Directions: Solve the word problems below using what
you have learned about saving money in a tax-deferred
account.
1. Mr. Johnson, is a 29-year old engineer for Spider Corporation.
He earns $52,000 a year or $1,000 a week. Each week he
contributes 5% to his 401(k) plan. How much per week
is he contributing to the 401(k) plan?
2. Mr. Johnson's company offers a 50% match with a 6% cap.
This match means that he will receive an extra $.50 for each
$1.00 he contributes to his 401(k), up to first 6% of his
contribution. How much money does he receive each week
from the company?
3. Should Mr. Johnson change his contribution to 6%? Why?
4. If Mr. Johnson where to contribute $7,500 a year to his 401(k)
plan, what would his gross taxable salary be? Explain.
5. Use the calculator at Java Financial Calculators to determine
the amount of money Mr. Johnson will have if he retires at 65
years of age. Use the assumption that the average annual return
will be 8.0% and he is starting at $0.00 balance. Base your
answers on the figures in question number one. Compare the
difference if he choose to contribute 6%.
http://www.dinkytown.net/java/RothIRA.html
Answers:
Question #1.
A. $50 a week contribution $1,000 x .05 = $50.00
Question #2.
A. $50.00 / 2 = $25.00
$25 a week extra from the company
Question #3.
A. Yes, because he would miss the opportunity
for additional "free" money.
At 6%, the company match would be $1,560. At 5%, the
company match would be $1300. Thus, he would
receive an additional $ 260.00 from his company.
Question # 4.
A. $52,000 (gross income) - $7,500 (contribution) =
$44,500 taxable income.
Question #5.
A. 5% contribution is equal to $731,680
6% contribution is equal to $876, 016
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Thank you for being a subscriber!
Enjoy the rest of your week.
Timothy Liptrap
Vice President, Education and Development
http://www.101financiallessons.com
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