How to make the best of your 401 (k) Plan

V. Kumar By V. Kumar, 24th Apr 2011 | Follow this author | RSS Feed | Short URL
Posted in Wikinut>Money>Pensions

401 (k) Pension Plans provide an excellent opportunity of preparing yourself for life after retirement. However, to make the best of this opportunity and ensure that it fits with your overall financial planning you should know about some basic rules and steps to be taken by you at different stages.

Know all about 401 (k) Plans

Finer legal prints may be difficult to follow for many of us. However, it make a lot of sense to go through the easily available material and be aware about what these plans basically mean, what are the conditions, the tax advantage etc., before you decide to invest in it.

For a beginner, 401 (k) Plans are 'defined contribution' retirement plans wherein the contribution of the employee ( and /or the employer) is defined, but the final benefit is variable (unlike pension, when it is fixed, usually as a percentage of last pay and depending upon the number of years served). These are called 401 (k) because they are regulated by the section 401 (k) of the Internal Revenue Code, which lays down the tax benefits that are available to them along with the rules that need to be followed for availing of those tax benefits.

Since the 401 (k) plans are in the nature of long term investment, you should go for them only if you are likely to be able to spare some of your compensation on a regular basis for a number of years. Although it is possible to borrow from your 401 (k) plan, it may not always be wise to do so.

Be aware of the limits of the contribution you can make to 401 (k) Plan

Every year, the IRS comes out with the limits on the maximum amount that can be contributed by an employee in a 401 (k) Plan. The limit prescribed by IRS for year 2011 is $ 16,500 for elective deferrals (which are eligible for tax advantage) and another $ 5,500 for catch-up contributions, extra contributions that people aged 50 years or more can make. However, these limits are also subject to the limits, if any, in the plan.

Your employer can make matching contributions to the plan, which is also limited. It is set at 6% of the employee’s pre-tax compensation. For this purpose, the maximum compensation to be considered is $ 249,000.

In addition to these contributions, you can also make additional (after-tax) contributions to the plan. However, the total of all contributions made should not exceed more than $ 49,000 in a year.

Make sure your Plan allows you to invest up to the Maximum limit permissible

Since you will be eligible for the tax advantage under 401 (k) only if your elective deferral is within the limit provided in your plan, hence while joining a 401 (k) plan, you must make sure that it will permit you to invest up to the maximum limit permissible under the IRS restrictions. In case you find that your plan is allowing you a lesser limit, make sure that the plan provider modifies the plan to your advantage.

Make sure you do not exceed limits

If you have more than one 401 (k) accounts, it is your responsibility that the total contributions made in those plans do not exceed the limits prescribed by the IRS.

This is very important, because if the contributions exceed the limits, they may be subjected to tax twice – first as part of your compensation on which withdrawal tax is deducted, and again when you finally withdraw that money.

Do not borrow indiscriminately

Borrowing from your 401 (k) is not always the best thing to do. So before you decide to go for it, know all about the pros and cons of that decision.

If you become a little aware of the rules that govern your plan, then with these simple steps you should be able to make the best of your 401 (k) plans.

(The limits of contribution given in this article are subject to any changes introduced by IRS. Readers are advised to confirm these limits before taking any action based on this info.)


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Meet the author

author avatar V. Kumar
I am a free lance author who writes for the sake of expressing myself. I like to share what I know and learn from the experiences of anyone willing to share it.

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