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Understanding the Pros and Cons of 401(k) Retirement Planning

By: Raymond Cheung

One of the most popular retirement plans operational in the USA and other developed countries which work on similar financial basis, 401(k) Retirement Plan is the first thing that comes to mind when an individual is planning to retire from active working life. First introduced in 1978 by IRC, or the Internal Revenue Code, the primary focus of the 401(k) Retirement Plan is to offer tax benefits to the individual on the sum of money which he is not withdrawing from his salary, but putting it aside for using after retirement. Currently this plan is implemented by the Employee Benefits Security Administration or ESBA under the Department of Labor.

The central corpus fund in the 401(k) Retirement Plan is generated by contributions made by employees through out the country as well as an equal contribution made by the respective employers. One could call this plan an employer-sponsored contribution plan. The biggest advantage of this plan, from the employee perspective is that his contribution towards the plan is completely free of tax, till such times that he withdraws his contribution from the corpus.

It is thus clear that with the help of 401(k) Retirement Plan, an individual can postpone income tax on the amount of his contribution, till he decides to withdraw. Though the age when an individual can withdraw from this plan is 59.5 years, money can be withdrawn under special emergency or dire situations. These situations include paying for mortgages, payments which one has to make to stop foreclosures, funeral or educational expenses, expenses envisaged for home improvements, and so on. In the event of withdrawal, a sum of 10% is deducted from the disbursed amount.

Investing in 401(k) Retirement Plan makes good sense as you can expect a huge sum of money as and when you retire. If you invest in this plan for 20 to 30 years the compounding benefit of 401(k) Retirement Plan is truly great. This is because the employer is also simultaneously contributing to your savings, which doubles your investment. If you change jobs, you could transfer your accumulated funds of the 401(k) Retirement Plan to your subsequent employers. The flexibility of the 401(k) Retirement Plan allows you to do so conveniently.

One of the main advantages of the plan that makes it popular is the tax-free nature of the contributions before they are withdrawn. And since the contributed income is not taxed, the member is able to get bigger savings compared to other investment plans. This is perhaps the only financial planning strategy which is not deducted with taxes.

But you must know that this plan is a disadvantage if you have to withdraw the funds in the investment before the age of 59.5 years. There is a penalty of 10% on preterm withdrawal. Also, you must know that the Pension Benefit Guaranty Corp. (PBGC) does not insure this plan. Another disadvantage is that the employer will not allow the plan to take effect until the employee puts in a few years of service, as decided according to their company policies. So, until that time, it will be only employee contributions, while contributions from employer will only come when the period of service is completed.

The 401(k) plan opens different investment opportunities for the contributor. He can choose to invest his savings in any investment method including treasuries, money market, stock funds or bonds.

An employee, who is quite sure of staying for a longer period in the company where he is presently working, should consider the advantages of the 401(k) plan. It is a good investment option but try to weigh the advantages and disadvantages before you decide if the 401(k) is the right investment vehicle for you. There are lots of investment options available for retirement purposes but so far it is the 401(k) retirement plan that attracts employees because they are not the only one contributing to their retirement fund since the employer also contributes to the fund making. Consider these options and decide which will benefit you in the future.

Article Source: Main Articles

The author is a contributing writer for Retirement Planning Software and specializes on subjects involving 401k retirement planning.

This article may be reproduced wholly or in part without written permission provided the byline, resource area, and any hyperlinks remain in order to give proper credit to the author.

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