There are, in general, two types of most important employee-sponsored retirement benefits: Defined benefits – DB, and defined contribution – DC.
In DB, the employer provides a certain amount to the retirees upon meeting the set criteria of eligibility. It can be either the service that they provide or meet the age limit. In other words, through the DB a certain amount of money is added to the final paycheck of the retiree.
The DC plan is not a benefit that the retiree receives, but a contribution the employer makes towards the retirement of the employee. There is no fixed amount, but a lump sum, so the employee does not know for sure what the final amount.
The section 401K of Internal Revenue Code states that through this new amendment, the employees will be able to contribute to their retirement plans, which will be without tax or pre-tax, into their 401K account.
How does it work?
The employee will make contributions to his or her retirement plan through the certain amount deducted from their paycheck at the end of every month before any tax is applied to it. This will happen only at the discretion of the employee.
The money will grow tax-free in their accounts.
What are the benefits and drawbacks?
- The company for which the employee works will set the guidelines, restrictions and eligibility criteria.
- The company may not allow the plans to be initiated for new members, non-US citizens and others.
- The contributions to the account may come from the employee, their employer/ company or both.
- Withdrawals before the age of 59 and a half years, the employee will be issued a 10% penalty.
- However, those retiring after they turn 55, will not be subject to the penalty.
- It is not mandatory for the employer to contribute to their employees’ 401K accounts.
- The average investment choices in the plans are 19. You can choose any from choices ranging from 8 to 25.
- These contributions to the plan may make the employee eligible to apply for a loan.
- Before the withdrawal, the money in the account will grow tax-free.
- If the employer contributes to the accounts, he or she may be eligible for tax benefits in some cases.
For the above mentioned, along with many other reasons, the 401K retirement account is very popular amongst employees.
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