I am often asked many questions regarding retirement accounts. With many available options these days it can sometimes be confusing to fully understand your rights as an employee.
Because your retirement planning is so important to your future well-being, you should ask questions about the retirement plans available to you and how they work, as well as how best to use your retirement dollars. Below are answers to several commonly asked questions about 401(k) Plans.
Q. How do my 401(k) contributions lower my income taxes?
A. Your 401(k) contributions are made on a pre-tax basis. This means that they aren’t reported to the Internal Revenue Service as current income on your W-2 form to the Internal Revenue Service. For example, if you earn $25,000 a year and decide to contribute 10 percent of your salary ($2,500) to your 401(k) account, only $22,500 will be reported as current income for income tax purposes.
Why does the government give you this excellent tax break? Because it wants to encourage individuals to save as much as possible with their own dollars today so that they are better prepared for their retirement in the future.
Q. What is a Roth 401(k)?
A. Roth 401(k) is not a type of plan, but rather a type of plan contribution. If a 401(k) plan offers this feature, employees can designate some or all of their elective contributions as designated Roth contributions, (which are included in gross income) rather than traditional, pre-tax elective contributions. Meaning that Roth contributions are taxed in the year they are contributed to the plan. Upon distribution, Roth 401(k) contributions are received tax free. Earnings on Roth 401(k) contributions will not be taxed upon distribution if the Roth account has been open for at least 5 years and distribution occurs after 59½ , death or disability. Traditional 401(k) contributions and Roth 401(k) contributions are subject to a combined limit of $16,500 for 2010 ($22,000 if age 50 or older).
Q. Am I able to contribute to both a 401(k) and an IRA?
A. Yes. Many individuals contribute to their 401(k) Plan and to an Individual Retirement Account (IRA) or Roth IRA. It may be best to maximize your traditional 401(k) contributions first, since they are made with pre-tax dollars. (Your IRA contributions may or may not be tax deductible, depending on your annual salary and other qualifications.) If your employer offers matching contributions and you qualify for a Roth IRA or deductible IRA, it may make sense to contribute enough to your 401(k) to attract the maximum employer match, and then contribute to an IRA or Roth IRA. If you have not exhausted the maximum allowable contribution and can afford to do so, contribute again to your 401(k) Plan.
Q. If I change jobs, may I take my 401(k) money with me?
A. Yes. All contributions you have made to your 401(k) account are 100 percent yours. Contributions made by your employer (if any) may be yours depending on a vesting schedule. You will need to check your plan for specific vesting schedules.
In addition, if you do change jobs, it may be a good idea to consider either rolling your 401(k) money over into an IRA or another qualified plan (such as a profit-sharing or 401(k) plan) at your new employer. Otherwise, you may incur taxes and early withdrawal penalties. Be sure to check with your tax adviser before taking any distributions from your 401(k) Plan.
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Matthew A. Klatsky, is a financial advisor in Morgan Stanley Smith Barney’s Hunt Valley, MD office. Matthew can be reached at (410) 229 8219 or www.morganstanley.com/fa/matthew.klatsky
Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney’s Financial Advisors do not provide tax or legal advice, are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein, except as otherwise agreed to in writing by Morgan Stanley Smith Barney. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisors before establishing a retirement plan and to understand the tax, ERISA and related consequences of any investments made under such plan.
This article is published for general informational purposes and is not an offer or solicitation to sell or buy securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives.
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