Retirement planning is a long process that requires due diligence, time, and effort to make it a success. It can be confusing at times, as you have to take into account several factors. A lack of a well-planned retirement plan could have repercussions on your retirement life and may even jeopardize your future financial security. Not everyone gets the opportunity to turn their dream of having a comfortable retirement into a reality, due to occurrence of unexpected financial emergencies. Other times, poor planning can be an obstacle to achieving your retirement goals. No matter the reason, an ill-planned retirement coupled with inadequate savings can affect your financial well-being. This is why it is important that you take necessary action to plan for your retirement wisely.
The 401k account is an employer-sponsored retirement account in America that has helped many people plan for retirement. It is a simple financial instrument that can be extremely beneficial to you when you begin financial planning. To know more about 401k accounts, its different types, and how you can best utilize it to maximize your savings for retirement, consult with a professional financial advisor.
What is a 401k plan?
A 401K-Plan is a saving and investment plan offered by most American employers to help the employee save for retirement. If an employee opts for the plan, a certain part of the employee’s monthly salary is deducted and paid into the 401k account. The contributions made by the employee are matched by the employer, either partly or entirely. While the contributions are not taxed, the withdrawals made during retirement are taxed. The funds in the 401k are invested into the employee’s choice of investments from the given list.
Usually, deductions from the salary are made on the pre-tax income. However, if a person opts for a Roth 401k, the deductions will be made after tax has been deducted. In this case, the withdrawals will be tax-free.
The 401k is a great plan; however, since it is sponsored by employers, you have to look out for certain issues that may arise along the way. A few of them are listed below, along with the possible course of action that can be taken.
What happens to your 401k plan when you leave your job?
If you leave your job, naturally, your employer will stop contributing to your 401k plan. In this situation, the employee has the following options at his disposal:
1. The employee can leave the money with the employer. If your 401k is worth more than $5000, you have the option to leave it with the employer. However, if it is lower than $5000, the employer can only hold it for a maximum period of 60 days, after which they will issue a check of the value of the 401k plan to the employee.
2. If your new employer also offers a 401k plan, you can carry forward your old 401k to the new one. This is a great option since it means that all your money will be held in one account and thus, will be easier to manage.
3. In case you do not have a job lined up or your new job doesn’t offer a 401k, you could open an IRA (Individual Retirement Account) on your own, independent from your employer, and transfer the funds from your 401k into it. Doing this also means that you will not have to pay any tax.
4. You could also cash out the 401k fund as cash distributions. However, doing so will result in you having to pay taxes and penalties. However, in certain cases, if you are 55 years of age or older, you are eligible to withdraw from your 401k without any penalties. But usually, you must be at least 59.5 years old to withdraw without penalties.
Note: With the implementation of the CARES Act, you will be exempt from paying penalties on early withdrawal from your 401k even if you are younger than 59.5 years.
While these are all viable options, you should try your best not to withdraw money from your 401k plan. If you withdraw from it early on, you will have to pay penalties and taxes and you will miss out on the long-term yields that you could have earned from the invested amount. Additionally, if you are nearing retirement, putting your 401k money into another retirement account and letting it grow instead of using it up would be a wiser course of action.
It is advised that you preferably not leave your money with your previous employers. You may change your job many times throughout your career. Leaving a 401k plan with each of your previous employers may scatter your retirement fund making it hard to keep track of. This may also lead to tax-related troubles at the time of withdrawal. Moreover, you can always divert the 401k money into an investment with better yields and lesser costs.
Note: If you have left a 401k with an old employer and can no longer find them due to reasons like shutting down of the firm and so on, the company may have listed you as a missing participant at the time of closing. You can check the national registry for unclaimed retirement benefits and see if you have been mentioned or search the Department of Labor’s Abandoned Plan Database.
What happens to your 401k plan if the company shuts down?
Any contributions made by you to your 401k account will always belong to you, and the company cannot deny those to you. Companies cannot legally hold any 401k plan funds. They are obligated to place the funds in a separate and independent entity, like a trust or insurance contract, to prevent misuse of funds. These laws have been put into place to ensure that the company’s creditors cannot access your money.
However, there are certain situations wherein you might lose your funds. These are:
- You have partial or full ownership of the contributions matched by your employer. The level of ownership usually depends on the vesting schedule. This means the longer you work with the employer, the more employer contributions will be vested into your account, i.e., you will fully own and have complete control over a larger share of money contributed in your 401k account.
- If a considerable portion of your employer’s contribution to the 401k plan is made up of company stocks, it will now have little to no value due to the company shutting down or going bankrupt, resulting in you most likely losing that money.
- A company is liable to deposit your 401k plan funds to a separate entity within 15 business days from the end of the month. If the company closes down before they can deposit the funds, you will likely lose that particular month’s contribution. It is recommended that you check your employer’s 401k statements (which can be accessed online) to ensure that the funds are being deposited promptly.
In case of a merger, usually, the two companies maintain the 401k plans separately. They may also be merged into the new company’s plan or be terminated entirely.
What happens if your employer does not release your 401k?
There are instances where an employer may refuse to release your 401k plan money. These are:
- If the employer’s summary plan description (an important 401k related document that describes details about the 401k plan like the eligibility requirements, benefit calculations, and so on) forbids employees from withdrawing before retirement or loans against your 401k, there is little that can be done in this case. It is advised that you read the summary plan description properly to avoid a situation like this.
- If you have taken a loan against your 401k plan, the company may restrict access to the funds unless you pay back the entire sum of the loan. Usually, a 401k loan is difficult to get because the qualification process for getting the loan is rather cumbersome. If you do get a loan, you are supposed to pay it back within 5 years. If you end up leaving the company before paying back the loan, you will have to clear the remaining loan amount within 60 days.
- Your employer may freeze your 401k account if you have any pending litigation against them. The account may also be frozen if there is a change in the entity responsible for managing the 401k accounts or if there is a merger and so on. Generally, a 30-day notice is given to the employees before such an action occurs. When your account is frozen, you will be unable to contribute or withdraw from the 401k account.
In these situations, it is advised that you contact your company and ask for an explanation and future recourse. However, if you believe that your access to your 401k account has been revoked unfairly and without explanation or if you suspect malpractice, you may pursue legal action by contacting the Department of Labor or an attorney.
What happens when your employer suspends their 401(k) program?
In the current economic climate, many companies have been cutting costs to stay afloat. This means that many employees may receive no benefits and could also lose their 401k plan. This can be a worrisome prospect for people saving for their retirement. However, there are other ways to save for your retirement.
You could open up an IRA on your own and roll your previous 401k funds into it. IRAs are not sponsored by employers, nor do you need to have a job to open one. When opening an IRA, you may be faced with two choices – opening a traditional IRA or a Roth IRA. The main difference between the two is the time of tax payments.
In traditional IRAs, you pay the contributions on your pre-tax income and pay taxes at the time of distribution of the IRA. Regardless of their income, any person is eligible to open an IRA. Whereas, in a Roth IRA, you pay the contributions on your post-tax income and do not pay anything at the time of withdrawal. However, not everyone can opt for a Roth IRA. There are certain income limitations that you have to comply with.
The above-stated method also works if you have no previous 401k plan and also if your employer does not offer a 401k program. The only disadvantage is that your funds will be much lower due to the absence of employer contributions.
A 401k plan is essential for your retirement planning. Before you opt for one, be sure to learn about its contribution limits, income limitations, tax implications, benefits, and more. Try not to withdraw money from your 401k as it can impact your future yields and also reduce your future income. Stay up to date with changes in the 401k plan to ensure that you invest and save wisely for your golden years.
Use Paladin Registry’s free advisor match tool to match with an experienced and certified investment advisor who can guide you effectively on how to effectively manage your 401(k) account and help you plan better for retirement. Give us basic details about yourself, and the match service will connect you with 1-3 professional financial fiduciaries that may be suited to help you.
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