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401k Retirement Plan Fundamentals

Most people are not well aware of the many functions and implications of their 401k plan. They find it confusing the way they can balance their retirement plan, when they can make withdrawals form it and how to do it. If you are one of them, read this article to get a deep understanding of what your 401k plan can offer you.

Functions of 401k Retirement Plans

Nowadays almost every company offers their employees 401k plans. After an employee has made his/her mind on making contributions to the company's retirement plan, s/he is given a list of mutual funds that can be included in the 401k. The financial experts of the company give thorough information on the exact mutual funds to facilitate the decision making of the employee. They will also clarify what percentage can be invested in the given mutual funds. After making all these decisions, the employer will make contributions on behalf of the employee, which are subtracted from the salary of the latter before taxes are deducted.

Unfortunately there are certain limits up to which an employee can make contributions to the retirement plan. However, many employers provide the opportunity of matching a percentage of the contributions made. The sums accumulated from the employee's contributions and the employer provided matching are then invested in the chosen by the employee mutual funds. The good news is that no taxes are charged until the age of 59 ½ and the money is left to grow undisturbed. However if you decide to make withdrawals before reaching this age you will be charged income taxes and penalties. Additionally, after the age of 59 ½ you can retrieve your money, which will be subject to an income tax.

401k Retirement Plan Essence

401k plans represent a retirement plan that is being sponsored by the employer. There are mainly two categories of 401k plans:

  1. Defined benefit 401k retirement plan

    After answering a predetermined set of criteria, the employer is required to pay the retiree a certain amount of money. The amount of service and final average salary are taken under consideration in this type of 401k plan. Additionally, the latter makes the prediction of the monthly retirement income of the employee easier. Some defined benefit 401k plans give the employees the opportunity to receive a lump-sum benefit upon retirement.

  2. Defined contribution 401k retirement plan

    The benefit that the employee is to receive after reaching retirement age is not defined. This type of 401k plan defines the amounts that the employer is obliged to contribute to the employee's retirement account. As compared to the defined benefit 401k plan, the employees are not able to determine their monthly retirement income, since the very nature of the defined contribution plan includes the benefits that are undefined. In case the employee decides to change his/her job, the company will pay him/her the proceeds in either:

    • annuity
    • current lump sum
    • deferred lump sum

Avoid putting your money into the stocks of the company you work for since in case of bankruptcy you will lose the accumulated money.

Declining 401k Balance

The main factors that determine the fixing of your 401k balance are age and the company's policy. This means that a young employee enjoy higher opportunities of rebuild of the retirement plan than those who have several years before reaching the age of 59 ½. In order to repair the negative consequences of the declining balance of your 401k, take a careful consideration on the way you make the investments. Remember, diversification is your friend, and if you have made the mistake of heavily investing in the stocks of your company, reduce the amount of latter and spread the money among other investments. Keep track of the new contribution limits, since they are different each year and adjust the amount of your contributions to maximize your future gains.

401k Balance

Suggested allocations Large cap stocks Mid cap stocks Small cap stocks International stocks Bonds Cash
Aggressive (35 or more years till retirement) 50% 15% 10% 10% 15% -
Moderate (20 years till retirement) 35% 10% 10% 10% 35% -
Conservative (10 years till retirement) 30% 10% - 10% 40% 10%

A 401k plan provides you with the opportunity to ensure yourself with a financially secure retirement years. Therefore, you should carefully consider the investments you make and especially how are you going to allocate your assets.

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