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The Nuts and Bolts of a 401(k) plan

Comparing your 401(k) to Other Retirement Plans

There are many different places to invest your retirement money, although you may not have the opportunity to take advantage of all of them. The following chart includes the major types of investments that are sources of retirement funds and explains how they compare to each other. Keep in mind that earnings grow tax-deferred in all the plans listed below, except for the Roth 401(k) and Roth IRA, where the contributions and earnings grow tax-free.

Plan

Eligibility

Contribution Responsibility

Is Employee Contribution Tax Deductible?

Is Withdrawal Subject to Tax?

Other Features

401(k)

Employee of a company that sponsors a plan

Employee and possibly employer

Money contributed pre-tax to plan reduces income subject to tax. Contributions to a Roth 401(k) are not deductible.

Pre-tax contributions are taxed on withdrawal. After-tax and Roth contributions are not taxed. All earnings are taxed on withdrawal (except Roth).

Your contributions are 100% vested. Employer contributions usually have a vesting schedule. Your plan may have borrowing provisions and may permit hardship withdrawals.

403(b)

Employee of a non-profit organization that sponsors the plan

Employee and possibly employer

Money contributed to plan reduces income subject to tax. Contributions to a Roth 403(b) are not deductible.

Pre-tax contributions are taxed on withdrawal. Roth contributions are not taxed on withdrawal. All earnings are taxed on withdrawal (except Roth).

Similar to 401(k) plan; Loans are subject to the same rules that apply to qualified employer retirement plans.

Pension Plan

Employee of a company that sponsors the plan

Employer. Some plans require mandatory employee contributions as a condition of participation. In addition, some plans may allow voluntary employee contributions in order for participants to earn a greater pension benefit.

Money contributed pre-tax to plan reduces income subject to tax.

Upon retirement, money you receive from the plan is taxed other than the portion attributable to your mandatory or voluntary after-tax contributions made to the plan.

You accrue benefits based on a vesting schedule. Once vested, your pension benefits are guaranteed, subject to certain limits, by the Pension Benefit Guaranty Corporation. You are always 100% vested in your own contributions.

Plan

Eligibility

Contribution Responsibility

Is Employee Contribution Tax Deductible?

Is Withdrawal Subject to Tax?

Other Features

SEP-IRA

Any self-employed individuals and their employees

Employer and possibly employee (SARSEP)

Money contributed pre-tax to plan under a SARSEP reduces income subject to tax. Note: New SARSEPs can no longer be established, but contributions can continue to be made to SARSEPs that were established before 1997.

Upon retirement, money you receive from the plan is taxed.

Easy to administer. Contributions are discretionary.

Keogh

Self-employed individuals and their employees

Owner and employee (in certain cases)

Money contributed to plan by self-employed individual reduces income subject to tax.

Upon retirement, money you receive from the plan is taxed.

May be set up as a defined contribution or defined benefit plan

SIMPLE Plan

May be adopted by employers with 100 or fewer employees who earn an amount defined by the IRS during the preceding year.

Employer and employee

Employee contributions to the plan reduce income subject to tax.

Upon retirement, money you receive from the plan is taxed.

May be set up as a SIMPLE IRA or SIMPLE 401(k) plan

Traditional IRA

Anyone prior to age 70½, with employment income. A non-working spouse can set up a spousal IRA.

IRA owner

Contribution may be tax deductible

Upon retirement, deductible contributions and all earnings you receive are taxed. If any non-deductible contributions were made, these will not be taxed. But the earnings on the after-tax contributions will be taxed.

Easy to set up and administer. Contributions are discretionary.

Plan

Eligibility

Contribution Responsibility

Is Employee Contribution Tax Deductible?

Is Withdrawal Subject to Tax?

Other Features

Roth IRA

Anyone with employment income whose modified AGI is less than that defined by the IRS. A non-working spouse may set up a spousal IRA.

IRA owner

No

After attaining age 59½, withdrawal will be tax-free provided the IRA is held at least five years.

Easy to set up and administer. Contributions are discretionary.

Annuity

Anyone

Annuity owner

No

Earnings on the annuity are taxed upon withdrawal.

Annuities can offer a variety of equity investment options or interest rate guarantees but may have contract related expenses.

Employee Stock Ownership Plan

Employee of a company that offers the plan

Employer

N/A

Upon retirement, value of the stock or cash you receive from the plan is taxed.

Once you reach age 55 and have completed 10 years of participation, you have the right to diversify 25% of your account balance (stock you received after 1986). You can do this all at once or over a five year period. In the sixth year, you can move out up to 50% of the remaining balance.

Group Universal Life Insurance

Employee of a company that offers the plan or member of an association that offers the plan

Policy holder

No

Earnings on the policy are taxed if a withdrawal of the cash value is made.

The cash value that accumulates tax-deferred in the policy can be used to supplement your retirement income either through borrowing or surrendering the policy.

Social Security

Most people need 40 credits (10 years of work) to qualify for benefits.

You and your employer

No

Benefits received may be taxed depending upon other income you earn during retirement.

Contributions to Social Security are automatically deducted from your paycheck. You must wait until age 62 to start receiving benefits; full benefits start at age 65 for those born before 1938. Monthly benefits are indexed to inflation.

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