Employee-Sponsored Retirement Plan
The employer-sponsored retirement plan may be viewed as an employer-provided pooled investment account that allows an employee to use a portion of their pre-tax earnings for retirement, savings, or other long-term goals such as paying university fees or buying a home. The contributions of its employees do not exceed a certain amount or a certain percentage (Ameriprise). The plan is an attractive and relatively easy way for workers to reduce their taxes and savings in the long run. Currently, this plan is a notable option that allows individuals to receive savings from employers for retirement.
The plan supports retirement savings primarily in two forms: regular contributions to a company plan or DC 401(k) plan and by government or nonprofit organizations – referred to as 403b or 457b (U.S. Department of Labor). Both plans are funded by payroll deductions, which reduce employees’ taxable income. The plan also provides a transfer option, meaning employees who change jobs can transfer plan balances to the same employer or the same plan.
Generally, a 401(k) member can begin withdrawing money from their plan upon reaching age without penalty. Any withdrawal permitted before age is subject to an excise tax equal to ten percent of the amount distributed (above the ordinary income tax that must be paid). This includes withdrawal to pay expenses due to hardship unless the distribution does not exceed the amount allowed as a cap under section 213 of the Internal Revenue Code on an employee for amounts paid during a taxable year for medical care (IRS). Amounts withdrawn are subject to the regular income tax of the member.
Some employers may ban one, some, or all of the previous causes of difficulty. To maintain the 401(k) income reduction tax benefit, the law provides that, unless an exemption applies, money must be held in a tax reduction plan or equivalent plan until the employee reaches age. Money is withdrawn before age is generally subject to a 10% punitive tax unless an additional exemption applies.
Particular Plan
Income taxes on pre-tax contributions and income from investments in the form of interest are tax taxes. The ability to carry forward income taxes to a period when tax rates may be lower is a potential benefit of a 401(k) plan. The income tax deferral option has no benefit if the member has the same tax rates on retirement as it did on initial contributions or interest and accruals. Capital investment income from a 401(k) account is not subject to capital taxes (U.S. Department of Labor). This ability to avoid this second level of tax is a major benefit of the 401(k) plan. Compared to investing outside of 401(k) plans, one pays more income tax, but one pays less tax overall with a 401(k) due to the ability to avoid taxes on capital gains.
For pre-tax contributions, I will pay no federal income tax on current income he or she puts aside in a 401(k) account but still pays the general 7.65% payroll taxes (Social Security and Medicaments). I am planning to earn $50,000 in a year and save $3,000 in a 401(k) account that year reports only $47,000 of income on the annual tax return.
Benefits
Most pension plans provide significant tax benefits. More often than not, money deposited into an account is not taxable income for the employee at the time the contribution is made. However, if the employer provides plans, the employer may receive a tax credit on the amount contributed, as if it were regular workers’ compensation. This is known as pre-tax contributions, and the amounts allowed to be contributed are quite small among the different types of plans. Another significant advantage is that the assets in the plan can grow through investment without the taxpayer being entitled to year-on-year growth. Once the money is withdrawn, it is fully counted as income for the year of withdrawal. There are many restrictions on contributions, especially for 401k and defined benefit plans (Ameriprise). These limits are intended to ensure that high-paid workers do not receive too much tax advantage on spending by lower-paid workers.
Risks
Unlike ERISA-defined benefit plans or banking institutions that maintain accounts, there is no government insurance for assets held in 401(k) accounts. Plans for sponsors in financial difficulty sometimes have funding problems. At the same time, financial liability is given priority in bankruptcy laws. When moving from one job to another, this should be considered by the plan member as to whether to keep the assets in the old plan or transfer the assets to a new employer plan or individual retirement agreement (Ameriprise). The fees charged by IRA dees can be substantially less than the fees charged by employer plans and usually offer a much wider choice of investment vehicles than employer plans.
Automatic Saving Deduction
The saver sets up an automated savings plan in which a percentage of their income is regularly put into a checking account on a regular basis. This type of savings is ideal for those who wish to increase their efficiencies without having to physically deposit monies every few weeks. However, the discipline to follow through on savings may be an alternative to the automatic saving deduction. I believe I am disciplined enough to adhere to this alternative, but I still would choose the automated savings method.
Works Cited
Ameriprise. “What to Know About 401(k) Plans.”Ameriprise.
IRS. “401(k) Plan Overview.”IRS.
U.S. Department of Labor. “Types of Retirement Plans.”U.S. Department of Labor.