With economic times becoming increasingly difficult, it’s ever more important to understand and take good advantage of the benefits that the government has to offer.
Let us weigh-in on the various investment and contribution plan options open to different kinds of employees.
The 401(k) plan (which gets its name from the Internal Revenue Code along with other plans) allows employees to set aside a percentage of their wage to a non-taxable fund.
- Allowable contributions to the non-tax yielding fund range from 2 to 15%, depending on the firm an employee works for.
- Although the contributions do not yield taxes and are deducted from taxable income, they are subject to taxes relating to social security.
- There are various investment opportunities to divert contributions to. It is highly recommended for those who are far off from retirement age to keep their contributions in an interest-yielding stock.
- For those facing intense financial difficulties, a hardship withdrawal is a potential resort. However, withdrawing before age 59.5 will cause an employee to incur large penalties and will account for the income tax for what was withdrawn.
Roth 401(k) Plan
Evidently, the Roth 401(k) Plan combines features of both the Roth and 401(k) plans. The following are its characteristics, which have been taken from the two plans:
- Funds still remain non-taxable as per 401. However, contribution is deducted from the after-tax income, and not the taxable income.
- Those who are aged 59.5 and over, and have had the account for at least 5 years are able to withdraw their contributions free of income tax.
- The plan does not offer restrictions in terms of income, offering opportunities to those in high-income levels.
SIMPLE 401(k) PlanThe cleverly named SIMPLE 401(k) Plan, which stands for “Savings Incentive Match Plan for Employees,” is an option for firms with a small number of employees, i.e. 100 or less.
- Although employers set a percentage of contribution, they are mandated to contribute to worker accounts at either 3% of worker contribution or 2% of employee salaries.
- Contributions made are not subject to tax, as in 401(k) plans.
- As with a 401(k) plan, employees can divert contributions to different investments.
- Withdrawals subject employees to painfully large sums and percentages.
Employee Stock Ownership Plans (ESOP)
ESOP plans allow employees to take hold of a share of the company’s profits, without imposing too many deductions on their payroll.
- Employees can acquire shares of stock through payroll withholding. Another possible method is for the company to take a portion of its shares for allocation among its employees.
- A company that allocates its shares imposes a tax on the value of the share granted. Otherwise, the share acquired by the employee can accumulate without incurring any tax.
- Acquiring shares of one and the same company is to place all your eggs in one basket. This is a case of high-risk, undiversified investment, as the fate of your investment depends solely on the performance of one firm.
Depending on the options offered by your company, it is best to further look into each of the prospective plans that can be availed. Each has its own advantages and disadvantages that have to be weighed relative to how your finances are allocated.