401(k) Plan Perks Make Them Very Attractive
Many people know that you can sock away a lot more green on a tax-favored basis in an employer provided 401(k) plan than you can a standard issue IRA, as well as, the fact that many such plans come with enticements to participate such as employer matching or other contributions.
But there are other perks that make 401(k) plans, should you have one available to you, potentially even more worthy of your consideration as a critical component of your financial plan.
Among these perks are:
Larger Catch-up Contributions: An employee can contribute up to $17,500 to a 401(k) in 2014, but only $5,500 to an IRA. For those ages 50 and older, a so-called catch-up contribution can also be made up to another $5,500 for a 401(k) plan, as opposed to only an additional $1,000 that can be contributed as a catch-up to an IRA. That's quite a lot more "catching up" that can be done!
Longer Participation and Tax Deferral: With a traditional IRA, a statutorily determined minimum amount must annually be withdrawn from the IRA beginning at age 70½, an exception being a Roth IRA. This is known as a required minimum distribution, or RMD for short.
But with a 401(k) plan, it is possible to push the RMD starting point back under certain circumstances. This is the case when you are still working and are not an owner of 5% or more the employer. If you qualify, you generally can delay the RMD starting point until the point that you actually retire.
Delaying the RMD makes financial sense because the longer you are able to defer taxation on amounts in the plan, the longer the money which would otherwise would go to pay Uncle Sam can continue to work for you, leaving you more in your own pocket.
And here's another nice fact, some 401(k) plans will allow you to transfer you IRA money into them, thus delaying the RMD on that money as long as you are working and otherwise qualify.
Earlier Withdrawal Age Without Penalty: On the other end of the spectrum from delaying withdrawals as long as possible comes the perk of being able to begin withdrawals earlier without penalty, if needed, than you can with an IRA.
With a traditional IRA, you typically cannot take withdrawals without paying a 10% penalty for early withdrawal until you reach the ripe old age of 59½. However, employees in a 401(k) plan who leave their jobs in the year they turn 55 or older are able to make 401(k) withdrawals without having to pay the penalty.
A note of caution; to qualify, it must be a taxable withdrawal. If upon leaving employment you transfer or roll over your balance to an IRA, you will then be stuck with the age 59½ rule.
Participant Loans: Although not usually the best retirement planning strategy, 401(k) participants are generally allowed to take from their account a loan of up to 50 percent of the vested account balance or $50,000, whichever is less. The loan must be paid back with interest, and if you leave employment with the loan still unpaid, the outstanding balance will be treated immediately as a distribution to you subject to tax and the early withdrawal penalty, if applicable.
Special treatment for employer stock: The stock of your employer (if your employer's stock qualifies to be held) gets special tax treatment when held in an employer-sponsored 401(k). Here's how - when you withdraw the employer's stock from the plan, the appreciation inherent in the stock won't be taxed until you actually sell it, and the sale will often qualify to be taxed at the more favorable long-term capital gains rates.
Again, a word of warning; be careful about rolling over the stock to an IRA, since doing so will subject the appreciation later to the much higher ordinary income tax rates upon subsequent withdrawal.
Institutionally priced investments: A lesser known and possibly applicable perk is available to large employers, who sometimes can negotiate institutionally priced investments for their 401(k) plans. As such, these investments may have lower costs than others can get on their own, such as in an individual's IRA. Obviously, the lower the cost, the more money ultimately left in your pocket.
These perks along with the ability to shelter over triple the amount of money (more if age 50 or over) from taxation make 401(k) plans an excellent financial planning tool. If you qualify to participate in one, at a minimum you should consider taking full advantage of the so-called "free money" that your employer will contribute to your account if you participate.
