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FAQs: Retirement

What is a 401(k) plan and how does it work?
A 401(k) plan is designed to help eligible employees build income for the future through tax-advantaged savings. Money you contribute on a before-tax (pre-tax) basis reduces your current income tax bill. You postpone tax on all the money in your 401(k) plan account while it remains in the plan. Later, when you receive a withdrawal or distribution of your plan money, you pay income tax on any money that has not yet been taxed. 401(k) plan is named after Internal Revenue Code Section 401(k) that makes this type of saving possible.

What are before-tax (pre-tax) contributions?
Saving under the 401(k) plan with pre-tax contributions reduces your current taxable income.

Contributions are taken from your pay before federal income taxes are deducted. In most areas, your contribution is made before state and local taxes are deducted as well. This reduces your current tax bill and puts more money to work for you in the plan earning investment return Let’s say you earn $1,000. If you contribute it to the 401(k) plan, your employer puts $1,000 in the plan for you before income taxes are deducted. If you want to contribute that same $1,000 to a regular savings account at a bank, your employer would first deduct taxes – let’s say 30%. That leaves you only $700 to put in your savings account. So, if you contribute $1,000 to the 401(k) plan, that reduces your current taxable income for the year by $1,000. If you’re in a 28% tax bracket, your current federal income tax savings on that $1,000 alone would be $280.

What is tax deferral?
With a 401(k) plan, your pre-tax contributions, any company matching contributions and all investment earnings are not taxed as current income. You defer, or postpone, federal income tax on these amounts until later – when you take them out of the plan.

What is a company matching contribution?
Some employers – by no means all – provide a matching contribution to the 401(k) plan. With a company matching contribution, the employer contributes a percentage of the eligible compensation you contribute to the plan. You must contribute to the plan to receive matching contributions. If your contributions stop for any reason, so do company matching contributions.

What is a variable company matching contribution?
With some plans that have company matching contributions, part or all of company matching contributions are tied to company performance. Here’s the concept: with a variable match, your efforts for the company pool with the hard work of others and may pay off with added contributions to your account. The company’s board of directors sets the amount of variable company match based on company financial performance.

How do I decide how much to contribute?
How much you contribute is completely up to you. Some people save the maximum to build their future financial security and to take advantage of the tax savings. If their plans feature company matching contributions, many people contribute at least the amount required to receive the maximum match.

Can I change the amount I contribute?
Yes. Your plan allows periodic changes in the amount you contribute.

Are there limits on the amount I can contribute?
401(k) plans have a minimum amount you can contribute as well as a maximum you can contribute. The plan maximum may be the same as or less than the IRS maximum on 401(k) plan contributions The following IRS rules and regulations govern the amount contributed to the 401(k) plan: annual dollar limit on the pre-tax contributions ($13,000 in 2004; up from $12,000 in 2003).

Your plan maximum may be less annual limit on the pay used to determine contributions ($205,000 in 2004; up from $200,000 in 2003) annual limit on total contributions to your account (the lesser of $41,000 or 100% of your pay for most plans in 2004, up from $40,000 in 2003) The requirement that employees at all levels of a company have the same opportunity to save through the 401(k) plan. This can affect the amount highly compensated employees can contribute to the plan.

Are 401(k) plan savings insured?
Those who manage the plan, called the plan fiduciaries, must operate the plan in the best interests of participants and beneficiaries. However, your savings are not insured by the same insurance that applies to banks under the FDIC, or savings and loans under the FSLIC. As a “defined contribution” plan, 401(k) plan benefits are also not insured by the Pension Benefit Guaranty Corporation (PBGC) as are some benefits promised under a “defined benefit” plan.

My company offers “investment options” and I choose how my money is invested. How do I choose which investments are right for me?
Many 401(k) plans offer a choice of professionally managed investment funds with varying levels of risk and potential for return. You may invest your plan money in one or more of the available funds. You choose the investment mix that’s right for you is true with similar investments outside the 401(k) plan, the value of many investments will fluctuate in response to changing market conditions. Historically, funds that have fluctuated more in value (had greater investment risk) have also provided returns that did a better job of outpacing inflation (had lower inflation risk). You need to weigh your investment objectives against those of each fund. Past performance is no guarantee of future results.

Can I change my investments?
You can change your investment percentages for your future contributions as well as for the money already in your account.

What is vesting?
Vesting refers to earning a permanent right to any company matching contributions and investment earnings on those contributions. You are always 100% vested in your own contributions to the plan as well as investment return on those contributions. If your employer contributes to the plan, a vesting schedule may apply to those contributions and their investment earnings. With a vesting schedule, you earn vesting in your company matching contribution account as you perform eligible vesting service for the company. As long as you are earning eligible service, you will continue to earn vesting service even if you are not contributing to the plan.

Can I get my money out of the plan while I’m still working?
The IRS allows a few ways to access 401(k) plan money. Your plan may allow any or all of them Plan loans. The IRS allows you to borrow from your account: generally up to the lesser of 50% of your vested balance or $50,000. You continue to postpone income taxes on the amount you borrow as long as you repay the loan as promised. Hardship withdrawals. You may be allowed to withdraw part of your account in the event of certain forms of financial hardship. You will have to pay taxes on the money you withdraw, including a 10% penalty tax if you withdraw money before you reach age 59-1/2.

You may only withdraw your pre-tax contributions if you are undergoing the following financial hardships:

How are plan expenses paid?
Administrative fees related to the cost of operating your plan may be charged to the investment funds in which your account is invested or deducted from your account. For more information on these fees, contact the plan administrator.

How is my money paid to me when I stop working for my employer?
When you stop working, you may receive the part of your account balance in which you are vested (have full ownership). If the value of your vested account balance is below a certain amount (generally $5,000 or less) your vested account balance will automatically be paid to you in a lump sum. If your vested account balance is above the limit, your benefit will be paid according to your plan rules. It may be paid in a lump sum, or different payout options may be offered to you

Payment may be made directly to you. Or, if you wish, you may have any part of the payment that is eligible for rollover paid directly to an IRA or another employer’s qualified plan that accepts rollovers.

When do my contributions stop?
Your contributions stop when you elect to discontinue them. Contributions also stop if You stop working for your employer. Your employment status changes so you are no longer eligible for the plan. You take an unpaid leave of absence. Your contributions reach the applicable maximum limit (either the plan’s limit or IRS limits).

Do I name a beneficiary to receive my 401(k) money if I die while my money remains in the plan?
Yes. You may name an individual(s), a trust, an estate or a charity. However, if you’re married, your spouse is automatically your sole and primary beneficiary. If you want to name someone other than your spouse as your sole, primary beneficiary, have your spouse sign the appropriate place on the form in the presence of a plan representative or notary public.

Can I name a different beneficiary (other than my spouse) if I get divorced?
You can always name a different beneficiary if your spouse provides written, notarized consent. If you get divorced, you may name someone other than your former spouse as your primary beneficiary unless there is a Qualified Domestic Relations Order (QDRO) from a court requiring benefits to be paid to your former spouse.

How do I make 401(k) contributions?
Your employer automatically deducts the amount you wish to contribute from your paycheck and automatically deposits it in your 401(k) plan account.

What taxes will I owe when I receive my 401(k) plan money?
When you receive your 401(k) plan money, either as a withdrawal or as a distribution after you stop working for the company, you must pay federal income taxes on the following amounts. Depending on where you live, you may also owe state and local taxes on your distribution.

Where can I get more information about the tax treatment of distributions from qualified retirement plans like my 401(k) plan?
You can find more information on the tax-qualified retirement plan payments in these IRS publications IRS Publication 575, Pension and Annuity Income IRS Publication 590, Individual Retirement Arrangements IRS Form 5329 which addresses the 10% penalty tax for premature distributions IRS Form 4972 which addresses special tax treatment for lump sum distributions You can get these publications online at , from your local IRS office, or you may call 1-800-TAX-FORM.

What happens when I reach age 70-1/2?
The IRS has special requirements that kick in on the April 1 after the end of the year in which you reach age 70-1/2 If you have already stopped working for your employer, you must begin receiving certain minimum payments from the plan. (The IRS will not allow you to postpone tax forever.) If you are still an active participant working for the employer at this point, your plan may or may not require you to begin receiving minimum payments before you stop working. Be sure to check to avoid any penalty taxes.

I’m young. Why start saving now?
You’re never too young to save, whether through the 401(k) plan or some other means of saving. The sooner you start, the longer you have to put compound investment return to work for you. You can even stop saving and still come out ahead of the person who started saving later For example, let’s take a look at Pat and Sam. Each earns a flat 8% annual return the entire time their money is invested. The employer does not make matching contributions. Of course, your investment results will be different. But this example gives you an idea of the difference starting early can make.

Pat starts saving $1,000 a year from ages 25 through 35, then increases to $2,000 a year from ages 35 to 45. Pat stops saving at age 45 but leaves the money in the 401(k) plan to earn investment return. At age 65, Pat has $280,800. Sam starts saving much later, but on the same pattern. Sam saves $1,000 a year from ages 45 to 55 and $2,000 a year from ages 55 to 65. Same dollar amount contributed over the same 20 years, but at age 65, Sam has only $60,200.