The most common types of employer-sponsored retirement savings plans are called 401(k), 403(b) or 457 plans and Thrift Savings Plans. Each of these plans have a different target audience:
* 401(k) plans are offered to employees of public or private for-profit companies.
* 403(b) plans are offered to employees of tax-exempt or non-profit organizations, such as public schools, colleges, hospitals, and churches.
* 457 plans are offered to employees of state and local municipal governments.
* Thrift Savings Plans are offered to federal civilian and uniformed services employees.
How do 401(k) Plans Work?
With a regular 401(k) plan, your money is deducted from your paycheck before taxes are withdrawn, which lowers your taxable income and therefore, lowers your taxes.
Many employers today have begun offering Roth 401(k) plans. Similar to the features of a Roth IRA, you don't get an upfront tax break, your account grows tax-free and withdrawals aren't taxed in retirement, provided you’ve had the account for at least five years and are age 59 ½ or older – or have become disabled.
If you leave your employer, you have several options with your 401(k) account balance:
* You can roll over your account balance into your new employer's plan.
* You can roll over your account balance into an IRA.
* You can withdraw your account balance in a lump sum cash payout.
The last option may sound tempting, but is usually not the best idea. Not only will taking a lump sum distribution significantly reduce your retirement savings, but you'll likely face tax consequences. You'll have to pay federal (and possibly state) income tax on the amount, plus a 10 percent early withdrawal penalty unless you qualify for an exemption. And lastly, because your employer is required to withhold 20 percent of your distribution for federal taxes, your cash payout could be significantly less than what you were expecting.
Burgos & Brein is the leading financial advisor and retirement planning firm in Apopka, Clermont, Kissimmee, Lake Mary, Maitland, Ocoee, Orlando, Oviedo, Windermere and Winter Park specializing in 401K planning.