HR Sucks… Part 1
To be clear, I don’t mean that Nancy in your Human Resources department sucks. I mean everything to do with all the paperwork given to you in a large folder when you start a new job.. sucks. And more than likely, you don’t pay close attention to it.
This is part 1 of a series of future posts related to employee benefits. I PROMISE that this is HUGE for you. At least in the long term.
Let’s focus on the most common plan you’ll see from Employers these days: 401(k)s and their non-profit cousin: 403(b)s
By definition, a 401(k) plan is an arrangement that allows an employee to choose between taking compensation in cash or deferring a percentage of it to a 401(k) account under the plan. The amount deferred is usually not taxable to the employee until it is withdrawn or distributed from the plan. However, if the plan permits, an employee can make 401(k) contributions on an after-tax basis (these accounts are known as Roth 401(k)s), and these amounts are generally tax-free when withdrawn. 401(k) plans are a type of retirement plan known as a qualified plan, which means that this plan is governed by the regulations stipulated in the Employee Retirement Income Security Act of 1974 and the tax code. Regular 401(k) – pre-tax. Roth 401(k) – post-tax.
All of that is more or less a fancy way to say that it is forced savings and there are rules related to it. The point of these employer-sponsored plans is for you to have money when you retire. So the basic premise is that most of the rules are there to make sure you are penalized for withdrawing the money before you retire. The penalty comes from the IRS and is in the amount of 10% (currently) of whatever you withdraw before age 59.5. There are some exceptions to this rule:
- You die, and the account is paid to your beneficiary
- You become disabled
- You terminate employment and are at least 55-years-old
- You withdraw an amount less than is allowable as a medical expense deduction
- You begin substantially equal periodic payments (IRS Rule 72(t))
- Your withdrawal is related to a qualified domestic relations order (QDRO)
Keep in mind there may also be additional rules related to your employer plan specifically so PLEASE ask someone in the know about your plan before making a withdrawal.
A few things to keep in mind…
First and foremost, with a Regular 401(k).. you will HAVE to start withdrawing the money in the year your turn 70.5. Uncle Sam will collect their taxes one way or another. At that time, the FULL amount of the withdrawal is taxable at your regular income tax rate. That means everything you put away PLUS all of the interest on it is taxed. Yep… it sucks.
With a Roth 401(k).. you never have to withdraw it because you have already paid taxes on it. That also means that all of the growth on it is completely tax free. AND if you end up never using the money, it’s also completely tax-free to your kids.
You will need to make investment choices in your 401(k). Please, for the love of G-d, make SOME election. I am not allowed to give specific investment advice, but any selection is better than no selection. If your plan offers models and/or has a financial adviser on the plan – please use them. They will, at a minimum, give you a decent allocation recommendation for your age group – and some advice is better than no advice at all. Yes, there’s a theme here.
Please send questions… there will be many parts to this but all posts are driven by questions from all of you!