FAQs
401k and Retirement Planning
What do you do with your 401(k) plan when you change jobs?
When you change jobs, you need to decide what to do with the money in your 401(k) plan. Should you leave it where it is, or take it with you? Should you roll the money over into an IRA or into your new employer's retirement plan? As you consider your options, keep in mind that one of the greatest advantages of a 401(k) plan is that it allows you to save for retirement on a tax-deferred basis. When changing jobs, it's essential to preserve the continued tax-deferred growth of these retirement funds, and to avoid current taxes and penalties that can eat into the amount of money you've saved.
How do you choose a beneficiary for your IRA or 401(k) ?
Selecting beneficiaries for retirement benefits is different from choosing beneficiaries for other assets such as life insurance. With retirement benefits, you need to know the impact of income tax and estate tax laws in order to select the right beneficiaries. Although taxes shouldn't be the sole determining factor in naming your beneficiaries, ignoring the impact of taxes could lead you to make an incorrect choice. In addition, if you're married, beneficiary designations may affect the size of minimum required distributions to you from your IRAs and retirement plans while you're alive.
A 401(k) plan is an employer-sponsored retirement savings plan that offers significant tax benefits. You contribute to the plan via payroll deduction, which can make it easier for you to save for retirement. Perhaps the most important feature of a 401(k) plan is your ability to make pretax contributions to the plan. Pretax means that your contributions are deducted from your pay, and transferred to the 401(k) plan, before federal (and most state) income taxes are calculated. This reduces your current taxable income. You don't pay income taxes on the amount you contribute--or any investment gains on your contributions--until you receive payments from the plan.
How do you take advantage of employer-sponsored retirement plans?
Employer-sponsored qualified retirement plans such as 401(k)s are some of the most powerful retirement savings tools available. If your employer offers such a plan and you're not participating in it, you should be. Once you're participating in a plan, try to take full advantage of it.
How do you borrow or withdraw money from your 401(k) plan?
If you have a 401(k) plan at work and need some cash, you might be tempted to borrow or withdraw money from it. But keep in mind that the purpose of a 401(k) is to save for retirement. Take money out of it now, and you'll risk running out of money during retirement. You may also face stiff tax consequences and penalties for withdrawing money before age 59½. Still, if you're facing a financial emergency--for instance, your child's college tuition is almost due and your 401(k) is your only source of available funds--borrowing or withdrawing money from your 401(k) may be your only option.
How do you save for retirement and a child's education at the same time? The Roth 401(k)
You want to retire comfortably when the time comes. You also want to help your child go to college. So how do you juggle the two? The truth is, saving for your retirement and your child's education at the same time can be a challenge. But take heart--you may be able to reach both goals if you make some smart choices now.
Beginning in 2006, employers can offer a brand-new option to 401(k) plan participants-- the ability to make Roth 401(k) contributions. If you're lucky enough to work for an employer who offers this option, Roth contributions could play an important role in maximizing your retirement income. What is a Roth 401(k)? A Roth 401(k) is simply a traditional 401(k) plan that accepts Roth 401(k) contributions. Roth 401(k) contributions are made on an after-tax basis, just like Roth IRA contributions. This means there's no up-front tax benefit, but if certain conditions are met, your Roth 401(k) contributions and all accumulated investment earnings on those contributions are free from federal income tax when distributed from the plan. (Beginning in 2006, 403(b) plans can also allow Roth contributions.)
What are your insurance needs in retirement?
Your goals and priorities will probably change as you plan to retire. Along with them, your insurance needs may change as well. Retirement is typically a good time to review the different parts of your insurance program and make any changes that might be needed.
After you retire, you'll probably focus more on your health than ever before. Staying
healthy is your goal, and that may require more visits to the doctor for preventive tests
and routine checkups. There's also a chance that your health will decline as you grow
older, increasing your need for costly prescription drugs and medical treatments. All of
this can add up to substantial medical bills after you've left the workforce (and probably
lost your employer's health benefits). You need health insurance that meets both your
needs and your budget.
How do you estimate your retirement income needs?
You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you'll need to fund your retirement. That's not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your goals and many other factors. However, by doing a little homework, you'll be well on your way to a comfortable retirement.
How do you tap your home equity?
There are two ways to tap your home equity if you're approaching retirement (or already retired) and don't want to make mortgage payments: You can trade down, or you can use a reverse mortgage. Trading down involves selling your present home and replacing it with a smaller, less expensive home. A reverse mortgage is a home mortgage in which the lender makes monthly payments to you, rather than you making monthly payments to the lender. Both of these strategies can give you substantial additional income during
retirement. Note: You could get money from your home by taking a home equity loan, where you place a regular mortgage on your home. But you must repay the home equity loan, with interest, like other regular home mortgages.
A top-hat plan is a type of nonqualified deferred compensation (NQDC) plan that is established to provide unfunded (employers don't formally set aside funds for these benefits; instead, they use their general assets) deferred compensation benefits only to a select group of management or highly compensated employees. A top-hat plan is exempt from most of the strict Employee Retirement Income Security Act (ERISA) requirements that govern qualified benefit plans and funded NQDC plans. As a result, top-hat plans can be extremely flexible in terms of which employees they benefit, the amount of the benefits, and when employees are entitled to the benefits.
What is a substantial risk of forfeiture?
A substantial risk of forfeiture is a standard applied by the Internal Revenue Service (IRS) to determine whether deferred compensation and transfers of property should be taxed currently to the payee. Generally, a substantial risk of forfeiture exists if an employee's right to deferred compensation or transferred property is contingent on the performance of substantial services in the future or on the occurrence (or nonoccurrence) of a given event. If these contingencies aren't met, the compensation or property is forfeited. When property is no longer subject to a substantial risk of forfeiture, it is usually said to have "vested."
What is Corporate-owned life insurance (COLI)?
Corporate-owned life insurance (COLI) is a life insurance policy that you take out on the life of one or more of your employees, whereby you are both the owner and the beneficiary of the policy. As owner of the policy, you're responsible for paying the premiums. As beneficiary of the policy, you retain all rights to the benefits under the policy. Other than being named as the insured, your employee has no interest in the policy.
COLI can be used for a variety of reasons, and the use of COLI may or may not bear any relationship to the actual financial loss you may anticipate upon the covered employee's death. For example, COLI is commonly used as an informal funding vehicle for nonqualified deferred compensation (NQDC) plans . When used as an informal funding mechanism for a NQDC plan, you can borrow against the cash value that accumulates under the policy, and you can then use the borrowed funds to pay the COLI premium payments or to pay the NQDC plan benefits.
What is Internal Revenue Code (IRC) Section 409A?
IRC Section 409A, added by the American Jobs Creation Act of 2004, is the first comprehensive legislation aimed directly at employer nonqualified deferred compensation (NQDC) plans . If a NQDC plan meets the requirements of Section 409A, plan benefits generally aren't subject to federal income tax until paid to participants. But, if a NQDC plan fails to meet Section 409A requirements, benefits are subject to tax and penalties as soon as they vest.
Caution: Congress left much of Section 409A's operational details to the IRS. On December 20, 2004, the IRS issued its first guidance, Notice 2005-1 . The Notice is detailed and complex. Many issues aren't yet addressed, some of the rules provided are temporary, and much more guidance is expected. This article, based on the statute, legislative history, and Notice 2005-1, will be updated as additional guidance is issued.
Caution: Section 409A does not replace any other laws or theories of taxation that have previously applied to NQDC plans. Even if compensation is not subject to tax under Section 409A, it may still be taxable under the constructive receipt doctrine, the economic benefit doctrine, the assignment of income doctrine, or other applicable law.