Retirement and My 401K Plan

The US economy, which is not doing so well, makes the future uncertain. Like others in my age group, I have started thinking about retirement and my 401K plan.  When I started working with my company in the early 1980's, I was automatically signed up with the company's 401K plan.  So you may be asking, "What is 401K plan?"

My understanding is the 401K plan is a retirement savings plan for employees.  The contributions I make to my 401K plan are matched with an equal amount by my employer. The 401K plan administrator is the company who is responsible for investing the money into stocks, bonds, the money market or a mix of any of these. The choice of where to invest his savings is with the employee.  In my case I opted to invest my savings in stocks and bonds.

Therefore, what is 401K plan and how does it affect my taxes?  My 401K plan allows me to be taxed only on my take-home pay net of my 401K contributions.  Upon my retirement after the age of 59-1/2 and I decide to make distributions from my fund which would naturally include interest and dividend earned, the distributions would be taxed only as regular income.  In this way, my 401K plan becomes a tax shield.   I am penalized with excise tax which is 10% of the amount if distributions are made before I reach the prescribed age, I am penalized with excise taxes amounting to 10% of the amount.  The penalty is over and above the regular income tax imposed and computed on the year the distribution was made.

If I want to avoid penalties my 401K plan allows me to take out a loan on my savings which I may repay in equal amounts over a period of not more than 5 years plus reasonable interest payments.   Loans for the purchase of my principal residence can be repaid for more than 5 years.   If I fail to pay my loan amortizations on time, my loan will be considered "in default". In this event, the balance of my loan becomes due and demandable, is treated as a regular distribution and therefore imposed the excise tax.

What will happen if I become disabled or I die before I reach the age of 59-1/2?   In the event that I become totally and permanently disabled, if I die or am terminated after the age 55 but before reaching the prescribed age, my 401K plan will allow me to close my plan with the company without being penalized.  And because my 401K plan amounts to more than $1,000 and I am terminated after age 55, I can close my account but will have to invest the funds into another similar retirement plan.  If I fail to do so before 6 months, it will mean I will be taxed like I made a regular distribution.

My 401K plan also allows for distributions intended for my financial needs that are immediate and require large amounts.  These distributions are known as hardship distributions.   The financial needs allowed under hardship distribution include medical expenses or that of my dependent family members.   Other allowances are for the purchase of, repair or amortization of my principal dwelling, tuition fees or funeral expenses.

I am contemplating retiring from the work force when I reach the age of 60 and go into business.   I expect to benefit from my 401K plan distributions by that time.  I have decided on a lump sum payment rather than being paid on instalment.  And this is how my 401K retirement plan helps ensure a worry-free retirement.