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Many employers provide a retirement plan for their employees. It may be defined as a 401(k), 403(b), 457(b), pension or profit-sharing plan. Some plans are subject to ERISA, which means the Department of Labor has jurisdiction over the plan. Other plans are not subject to ERISA and the employer is not required to comply with those regulations. The employer plan can define who is eligible to participate, who will receive certain contributions, the benefits available and the conditions under which those benefits may be paid. Each plan is designed for the unique characteristics of the employer; therefore, one plan may include loans, while another may not. As a participant in the plan, you may receive a Summary Plan Description that provides a "plain language" description of the program and its provisions. If you have questions regarding your plan, you should check with your employer's plan representative for assistance.

Deferring To A Plan

Today, many employers offer their employees the opportunity to participate in a 401(k) or 403(b) retirement plan. These programs allow participants to defer a portion of their wages before certain income taxes are applied to the paycheck. Contributions are applied to the plan and earnings are applied to the participant's account on a tax deferred basis.

Popular defined contribution plans such as a 401(k) require employees to complete a Salary Deferral Agreement, electing to defer a portion of their wages to the plan. The election is applied to the payroll program and funds are withheld when paychecks are issued.

An employee may generally modify or stop deferrals to the plan at specific times during the year. Each plan has the ability to define these dates and participants should check the Summary Plan Description or check with their plan representative to determine the permitted change dates.

Selecting Investments For Your Account

A plan may allow participants to select investments for their accounts from a group of mutual funds offered by the Plan. Choosing funds is an individual’s preference or tolerance for risk. A participant who is uncomfortable with fluctuations in their account may invest in funds from a conservative category. Another participant may remain committed to a certain investment mix whether the market is rising or falling.

Salary Reduction Plans generally conduct educational enrollment meetings with the assistance of the investment advisor selected by the plan sponsor. During these meetings, participants are provided information on the plan’s investment options and professional assistance with their retirement planning.

Taking A Participant Loan

Although participant loans are not offered by all plans, many sponsors include the option as a method for employees to save and use those savings to pay certain expenses. Participants who borrow from their retirement plan are required to pay interest on the principal amount and make scheduled payments to the plan based on the plan's loan policy.

A number of rules apply to participant loans and participants should read and understand the plan's requirements before requesting a loan to ensure that the distribution does not result in a taxable event. For example, if the individual leaves his or her job and payments are not maintained, the plan may be required to treat the loan as a distribution.

Taking A Hardship

A plan sponsor may also elect to permit employees who experience a financial hardship to take an in-service distribution from the Plan. The employer may permit hardship payments from employee deferrals only or include matching and non-elective balances as well.

Regulations permit financial hardship distributions for:

  • Purchase of a primary residence
  • Post-secondary educational expenses for the participant or a dependent of the participant
  • Payment of unreimbursed medical expenses
  • Expenses resulting from a natural disaster
  • Funeral expenses for the participants or a dependent of the participant
  • Payments to prevent eviction of employee from primary residence or foreclosure on mortgage on primary residence.

Before a hardship distribution can be made, the participant must receive any funds available to the participant. This includes any loan that can be received from any plan of the employer unless the loan would create an additional hardship on the participant. Hardship distributions are subject to ordinary income taxes and if the participant is under age 59 1/ 2, an additional 10% penalty may be assessed to your account

Roth Vs. Traditional 401(k)/403(b) Deferrals

With the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), 401(k) and 403(b) plan sponsors can allow traditional or Roth salary deferrals in their plan. Generally, traditional deferrals are made on a tax-deferred basis with income and contributions taxed at the time the plan assets are distributed to the employee or beneficiary.

Under a Roth option, participants are allowed to defer the same amount as in a traditional 401(k) or 403(b), but the Roth deferrals are withheld after taxes have been applied to the contribution amount. Deferrals can also be split.

Although the deferrals to a Roth 401(k) or 403(b) are made with post-tax dollars, the earnings on Roth contributions will be tax free, if distribution is made at least 5 years after the first Roth contribution and the attainment of age 59 1/2, death, or disability. Roth contributions may be more advantageous to younger workers who are currently taxed in a lower tax bracket, but anticipate being in a higher bracket at retirement. There are several additional considerations for Roth accounts and participants are urged to discuss the option with their tax advisor before making or changing deferrals from the traditional deferral account.