A 401(k) was never designed to be a “retirement plan”. It was designed to replace defined benefit plans which were retirement plans. The 401(k) is a savings and investment plan the IRS allows to defer income taxes on contributions, employer matching, and earnings until they are withdrawn. It is part of a retirement plan that also should include, social security, spending wisely, other savings, etc
The community of financial planners generally agree that only about 33% of your retirement income needs can come from social security if you expect retain a similar lifestyle after retirement…you need to plan to come up with the remaining amount…or cutback your lifestyle(maybe severely)…or work longer. The 401(k) is a means for saving first…not picking the hottest mutual fund.
A section 401(k) plan is a type of tax-qualified deferred compensation plan in which an employee can elect to have the employer contribute a portion of his or her cash wages to the plan on a pretax basis. Generally, these deferred wages (commonly referred to as elective contributions) are not subject to income tax withholding at the time of deferral, and they are not reflected on your Form 1040 since they were not included in the taxable wages on your Form W-2 . However, they are included as wages subject to social security, Medicare, and federal unemployment taxes.
The amount that an employee may elect to defer to a 401(k) plan is limited by the Internal Revenue Code. In addition, your elective contributions may be limited based on the terms of your 401(k) plan. Refer to Publication 525, Taxable and Nontaxable Income, for more information about elective contributions. Employers should refer to Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), for information about setting up and maintaining retirement plans for employees, including 401(k) plans.
Distributions from a 401(k) plan may qualify for optional lump-sum distribution treatment or rollover treatment as long as they meet the respective requirements. For more information, refer to Topic 412, Lump-Sum Distributions, and Topic 413, Rollovers from Retirement Plans.
Many 401(k) plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Generally, hardship distributions from a 401(k) plan are limited to the amount of the employees’ elective contributions only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions.
Distributions received before age 59 1/2 are subject to an early distribution penalty of 10% additional tax unless an exception applies. For more information about the treatment of retirement plan distributions, refer to Publication 575, Pension and Annuity Income.
The 401(k) is a deferred compensation plan designed to be be used primarily for retirement. There are exceptions provided in the code for using the money before retirement. The 401(k) is called a “retirement plan” as a force of habit, but it is by no means intended to by be a person’s “financial plan for retirement.”
Planning for retirement should be a methodical process. Determining how much money you will need in retirement can be done reasonably accurately with a computer program…if the program is given correct information. The correct information is the difficult part of the puzzle. That information keeps changing and the program must be up dated regularly at least on an annual basis.
Using a the 401(k) as part of a plan for retirement, is something like firing a guided missile. If a pilot is trying to hit a target with a smart “bomb” he/she doesn’t make wild swings and gyrations with the missile and then try to bring it online with the target at the last minute. The pilot doesn’t try to change weapons or targets in the middle of the flight of the missile. To hit the target, the pilot must focus the missile on the target and keep it there until it hits the target…if he doesn’t…it misses.
Consistent, persistent investments into your 401(k) are the best way to have and KEEP your 401(k) assets as part of your plan for retirement. There are always reasons to stop contributing, to take risks with your retirement money with the given investment choices and to take the money out for some “important” reason. Deviating from the 401(k) plan’s target of being a significant contributor to your plan for retirement means aborting the mission, firing another “missile” with less impact, or suffering collateral damage (mainly to your retirement income). Stay focused on the right target for your 401(k).