401K plans - Understanding Defined Contribution Plans, 401 K Company Retirement Accounts

The Series 7 and other securities, adviser and principal exams will ask questions on 401k plans and retirement accounts.

401k Accounts

401 k accounts are a type of defined contribution account.

A corporate retirement plan where the employee contributes a defined amount based on earnings or other factors. It is a tax qualified retirement plan. Eventual investment and retirement value of the account may be transferred or rolled over into another corporate plan.

These are different from defined benefit set ups where the amount put in by and for the employee is packaged with years of service, salary and other factors to calculate a monthly benefit. Contribution retirement accounts are taken out, transferred or people can do a rollover.

The years of service and amount of contributions will effect the account balance and asset allocations are a factor in the performance of the investments and rate of return. This is also true in defined benefit corporate retirement plans.

Contribution plans like 401k's and group IRA accounts are much more popular than benefit arrangements nowadays. With much of the workforce employed with small business or non union type companies, the need for providing a fixed monthly benefit at retirement and calculating that benefit over time is less appealing to a company when a 401k or other employee controlled plan is easier for the company.

Many people feel it is because of the growing aspects of defined contribution plans that less people are saving enough money in their retirement accounts.

Retirement Planning Help or Questions

401 k Rollovers

401k plans have some specific rollover and transfer rules and procedures. A rollover is when money is taken out of a 401k or other qualified retirement plan and "rolled over" into another type of qualified plan. These other plans include IRA's. Each time a rollover is done out of a 401k plan, it must be completed within 60 days and the money may not be cashed or placed in another account during that time. Rollovers can only take place once a year. An account transfer does not have to follow the 401k rules and guidelines. An account transfer is when a 401k plan is moved from one brokerage firm to another. Loans may be also taken on 401k balances. Cash withdrawals are subject to the pre 59 1/2 years old IRS standard penalty of 10% on the amount withdrawn and the total amount is taxed as ordinary income for tax purposes.

Vesting

The vesting period in a 401k investment account is the time the employee must fulfill their years to ne 100% vested. This means all contributions made by the company under the plan are 100% available to the person should they leave their job. The vesting period under these accounts can vary. Usually this period runs 5 years.

Investments

The securities account or investments within the 401k are varied with each plan or company. Usually, the employee will have a wide array of mutual fund or other fund choices to dedicate investment money to. The investor can change the allocation and choices in the 401k as they see fit. Rates of return and retirement value will vary with the performance of the securities in the investment account.

For employees and employers in a company contribution plan, the vesting period is an important period of time. A retirement account, like a 401k that is provided by a company (employer) is largely done as an incentive or loyalty benefit.

Being vested or 100% vested is on the part of the employee. If the employee remains with the company for a set number of years - as stated when they signed onto the plan, then the contributions made by the employer are now 100% the employee's. This vesting period can be set up a number of ways but is usually 5 years.

When the employee makes a 401k contribution, that money in the account is always 100% for the employee and would be available to the person for any rollover or job switch - as long as it is permissible for tax reasons. The amounts matched by the employer in the retirement account may only be partially under the worker's benefit to rollover or move. This depends on the vesting schedule and how long the person has remained with the company.

This vested part of the account is no all or none. An employee can be 40% vested, 70% vested etc. They do not have to be 100% to gain some of the company contributions made into the retirement account.

The period is not a long time for most employees and it is only fair for a company to have a set period of stay before the money the business has contributed to you is 100% yours. Filling this period of time is a normal part of 401k retirement account planning.