In this series of three-part articles on 401 (k) plans, we’ve covered the basics of what a 401 (k) plan is and what types of contributions can be made. In addition, there are other rules and guidelines that participants should be familiar with.
Acquisition is a term used to describe the point at which a 401 (k) participant is entitled to 100% of the employer matching contributions to their retirement account. The participant, of course, is always entitled to 100% of his or her own contributions, but employer matching contributions are usually subject to an award schedule, ranging from three to seven years. The purpose of the award schedule is to encourage employees to stay with the employer. Your 401 (k) plan document and your employer can tell you what the grandfathering schedule is for your plan.
Here is a brief example. Let’s say Suzy Smith contributes to her 401 (k) plan and her employer matches her contributions by up to 50%. The employer has selected a 5-year award schedule for the plan, and Suzy receives 20% each year. Your outfit would look like this:
After year 1: 20% conferred on employer matching contributions
After Year 2: 40% vested in employer matching contributions
After Year 3: 60% vested in employer matching contributions
After Year 4: 80% of employer matching contributions
After Year 5: 100% of employer matching contributions
401 (k) withdrawals
Before contributing to a 401 (k) plan, you’ll want to familiarize yourself with the ways you can withdraw your money. To some extent, those conditions will be dictated by your 401 (k) plan document. These are the acceptable withdrawal methods:
– Withdrawals due to financial difficulties
– Termination of employment
401 (k) loans
Not all 401 (k) plans allow loans, but those that do will require repayment. Loan payments, including interest and principal, are repaid directly to the employee’s 401 (k) account. The plan document will specify whether the plan allows loans and, if so, what conditions apply.
Hardship 401 (k) withdrawals
Some 401 (k) plans have provisions for hardship withdrawals, allowing a participant to withdraw contributions within certain limits and for specific reasons. Those reasons generally include medical expenses, the purchase of a home, college tuition for the next 12 months, or to avoid eviction or foreclosure of the employee’s primary residence. Again, the plan document will specify the rules that apply.
Termination of employment
When a 401 (k) participant leaves an employer due to resignation or termination, they are entitled to the balance acquired in their 401 (k) account. The plan document will specify how and when this recall takes place. In the event of adverse tax consequences, the participant should speak with their financial advisor to determine whether a rollover to another retirement plan such as an IRA is appropriate.
401 (k) withdrawals made at retirement age are called distributions. Before age 59½, distributions are taxable and generally subject to a 10% penalty. After age 59½, lump sum distributions will be subject to current income tax rates and taxes, but distributions may be eligible for a 10-year average special tax treatment. The money can also be withdrawn and transferred to another qualified plan, IRA, 403 (b) or 457 plan. For additional information on these options, participants should speak with their financial and tax advisers.
We have covered a lot of 401 (k) information. in the last three articles, but there is still much more to know. If you are investing in a 401 (k) plan, or considering it and have questions, contact your financial and tax advisers for recommendations based on your financial situation.