Employers are increasingly adopting retirement savings plans to replace or supplement traditional pension plans. These newer types of plans are named for the sections of IRS Code that authorize them, such as 401(k), 403(b), and 457.
UNION WORKERS ARE MORE LIKELY TO HAVE
HEALTH AND PENSION BENEFITS, 2007
Note: Defined-benefit pensions are a subset of all pensions. Disability refers to short-term disability benefits.
Source: U.S. Bureau of Labor Statistics, Employee Benefits in Private Industry, March 2007. August 2007.
Prepared by the AFL-CIO.
How are they different from traditional pension plans?
Traditional pension plans are considered "defined-benefit plans" because the "benefit," or amount you will receive when you retire, is determined by the plan. The plan trustees and your employer are responsible for making sure there is enough money in the plan to pay your benefit.
Retirement savings plans are called "defined-contribution plans" because the amounts contributed to the plan are largely defined by you. The benefit when you retire depends on the performance of the investments in your account.
Not so fast — the IRS has some say in the matter, too!
In order to benefit from the tax advantages of a retirement savings plan, some restrictions apply. For example, contributions are usually limited to a certain percentage of your salary, up to a fixed dollar amount. When you get closer to retirement, you may be able to contribute more under "catch-up" provisions.
Your employer's role in the plan can vary, too. Some plans allow an employer to automatically contribute a certain dollar amount or percentage of your pay. Others let your employer match the dollar amount of contributions you make. Still others do not permit employer contributions, or give your employer the option not to contribute.
If you're not sure what your company's plan allows, check with your union rep, human resources office, tax preparer and/or IRS publications to get the information you need.
The 401(k): A virtually painless way to save for retirement
To simplify the rest of this discussion, we'll focus on 401(k)s since they're the most common kind of employer-sponsored plan. And with good reason: once you sign up, there's no easier or more painless way to save.
- Contributions to your plan account are deducted from your paycheck, which means you never handle the money, can't spend it and probably won't even miss it.
- Income tax is postponed on your savings. You don't have to pay the IRS on anything you earn — interest, dividends or capital gains — until you withdraw the money. Ideally, you'll be retired then and in a lower tax bracket. In the meantime, your savings will have a chance to grow faster because you don't have to dip into them every year to pay taxes.
- You get an immediate tax break. That's because your contribution comes right off the top of your gross pay, lowering your taxable income. For example, if your gross salary is $50,000 and you contribute $3,000 to your 401(k), your taxable income becomes $47,000. If you're in the 15% tax bracket, that saves you $450 in taxes next April 15. In the 28% bracket, you'd keep $840. (Note: 401(k) contributions are still subject to FICA tax withholding.)
- Be sure to find out if your employer will contribute to your account — that's free money! Some companies match (in cash or company stock) 50% to 100% of every dollar their employees put in. That means the more you contribute, the faster and larger your account will grow. If you have the option, go for it!
Can I take money out of my 401(k) while I'm still working?
Under some circumstances, you may be able to make a withdrawal for hardship, or sometimes to buy a primary residence. In addition, many 401(k) plans allow you to borrow up to 50% of the amount in your account, provided you pay the money back with interest.
But since the idea is to accumulate money for retirement, it's typically NOT a good idea to dip into these funds. Taking money out of your account before retirement age will also trigger a tax bill, and sometimes a 10% early-withdrawal penalty.
If you leave your job, you may be able to keep your 401(k) account in place. Otherwise, roll it over directly into an IRA.
The remarkable Roth 401(k)
If your employer offers a Roth 401(k) option, consider taking advantage of it. This new kind of retirement plan combines the convenience of a regular 401(k) with a Roth IRA's potential for tax-free withdrawals. You contribute after-tax money, not pretax money as with a regular 401(k). But by meeting certain requirements, you can avoid ever paying taxes on whatever those contributions earn — which, over the years until you're ready to retire, could be a lot.
Don't wait to start saving — just do it!
You may be intimidated by investment choices, or feel that you don't have enough money in your paycheck. But the sooner you get going, the longer your money will have the opportunity to grow.
So don't let any more valuable time slip by before beginning to make your financial future more secure. If you're not automatically enrolled in your employer-sponsored retirement plan, sign up now. You can start with a very small contribution if you need to — but get started!
Important: Laws and Rules Frequently Change
In August 2006, President Bush passed the Pension Protection Act of 2006 which includes many provisions that will affect defined-contribution plans—many of which require more communication and disclosure to the participants about their plan features and benefits.
To stay informed about changes, it's important that you:
Find out what 401k retirement plans or other retirement employee benefit plans your employer offers and how much you can start contributing today!
NOTE: Union Privilege/Union Plus does NOT administer retirement plans or retirement account plans. Contact your union rep, human resources department and/or employee benefit plan administrator for details on your options.
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