Finance Roll

A 401k is a kind of individual retirement plan that has to be sponsored by an employer. The difference between this and an IRA or Individual Retirement Account is that a person can set up an IRA on his own. A 401K is usually set up for you by your employer.

Retirement Planning
There are three big advantages to a 401K: it is tax-deferred which means funds in one can be deducted from your taxable income until they are spent, it is very flexible so funds in it can be invested in a widely variety of instruments and employers can make contributions to the plan. The employer can either contribute a set amount or match the contributions that you make. Most contributions will be deducted from your salary.

401K plans are defined contribution plans created to take the place of pensions. In a traditional pension or defined benefit plan the employer pays retirees after they retire. This arrangement can quickly fall apart if the employer goes out of business. In a 401K the money will be available whether or not the employer is in business. Another advantage to a 401k is that the funds can be rolled over into another retirement account if you change jobs.

Drawbacks to 401ks
Even though most of us have heard how wonderful 401ks are there are some significant drawbacks to them. The first is that you are limited to the amount of contributions you can make this limit is usually $5,000 a year. That means they are not useful for older persons who may not have saved up enough for retirement.

Another and even bigger drawback is that you will have to pay income tax on funds withdrawn from the plan and benefits received from the plan at your normal rate. To make matters worse persons who withdraw funds before age 59½ will have to pay an extra 10% in income tax penalties. That means a 401k should not be used as a savings account or a cash reserve.

People who are making the maximum contribution to their 401k should definitely consider other kinds of retirement plans such as deferred annuities. There is no limit on the contributions you can make to a deferred annuity and it is also a tax deferred plan. Annuities also provide more insurance benefits than 401Ks do.

Roth 401k
A Roth 401k is a savings mechanism that is not tax deferred instead it is actually tax free. It works like this you pay income tax on contributions but no federal income tax will be due on funds in the plan or withdrawn from the plan in the future although the 10% tax penalty is charged on withdrawals before age 59½. A person can put more money in this plan and make contributions to it longer. You will have to start receiving payments from a normal 401k at age 65 or so. You can keep contributing to a Roth and not receive payments until 70½ if you wish.

Two Things You Might Not Know about Your 401k
Two things most 401k holders don't realize about their plans are that you can make purchase annuities through your 401k and you can roll your 401k over into annuity. Rolling over means you can move the money into another instrument without loosing the tax deferment. That means a person could move the money in a 401k into an immediate annuity when they retired.