Windes & McClaughry Accountancy Corporation

401(k) FAQs

1	What is a 401(k) Plan?
2	What are the advantages of the 401(k) Plan?
3	Who should participate in the Plan?
4	What are the limits on contributions?
5	Will the employer match my contribution?
6	What if I am over 50 years old?
7	How will this affect my compensation?
8	How will this affect my taxes?
9	What is the Saver’s Credit?
10	Why start making contributions now?

What is a 401(k) Plan?

A long-term, tax sheltered savings plan for retirement that permits eligible employees to make before-tax elective contributions within certain limitations.

What are the advantages of the 401(k) Plan?

Contributions are made with "before-tax" dollars
Investment growth is tax deferred
Payroll deduction will create automatic savings
401(k) before-tax deferral of otherwise taxable income can replace an IRA deduction

Who should participate in the Plan?

Everyone should participate, including:

Anyone currently saving money on an after-tax basis
Anyone interested in finding ways to reduce income taxes
Anyone approaching or planning for retirement
Anyone too young to be actively thinking about saving for retirement
Anyone who wants to save, but just never seems to get started on a systematic program

What are the limits on contributions?

An employee may defer up to $15,000 of calendar 2006 income. That amount will increase by cost of living adjustments after 2006.

Will the employer match my contribution?

On a year-to-year basis, the employer may match your contribution. Some plans have a specific fixed match and some matches are discretionary. Some 401(k) plans provide a safe-harbor matching contribution that is disclosed in a notice issued prior to the beginning of the year. A safe harbor match would be at least 100% of deferrals up to the first 3% of compensation, and 50% of the deferral up to the next 2% of pay. As an alternative to a match, an employer may choose to contribute a safe harbor contribution of 3% of pay that is allocated among all eligible employees regardless of whether they are making elective deferrals.

What if I am over 50 years old?

Provided that a plan participant is at least 50 years old during the plan year, and if the plan permits, additional 401(k) contributions may be made. For 2006 the limit is an additional $5,000. These special “catch-up” contributions are treated the same as regular 401(k) contributions, except that they are not subject to discrimination testing.

How will this affect my compensation?

SAMPLE PAYCHECK COMPARISON

Current Check
Without 401(k)
Deferral

New Check
With 401(k)

Deferral

Change

Gross Pay

401(k) deferral

Taxable Income

SS Tax/Medicare

Federal Income Tax

State Income Tax

State Disability Tax

Net Take Home Pay

$1,000.00

0.00

1,000.00

(76.50)

(105.00)

(10.85 )

(9.00)

$ 798.65

$1,000.00

(100.00)

900.00

(76.50)

(90.00)

(7.21)

(9.00)

$ 717.29

$ 0.00

(100.00)

( 100.00)

15.00

3.64

( 81.36)

The net result of $100 elective deferral per paycheck is a reduction in the take home income of only $81.36. The entire $100 elective deferral amount will be invested in the retirement plan trust, and an immediate investment return may be realized to the extent of an employer match on elective deferrals.

How will this affect my taxes?

As shown above, total income taxes are reduced by making an elective deferral to a 401(k) plan. No current income tax is due on investment income in the 401(k) plan account. The illustration below is based on a savings pattern of $100 per month ($1,200 a year). The illustration demonstrates the growth over a period of years of a $1,200 per year investment before tax through a 401(k) retirement plan vs. after tax.

With a 401(k) Plan

Without a 401(k) Plan

Year

Total
Contrib.

Bal. At
Yr. End

Total
Contrib.

Bal. at
Yr. End

Difference

2
3
4
5
6
7
8
9
10
15
20
25
30

$ 2,400
3,600
4,800
6,000
7,200
8,400
9,600
10,800
12,000
18,000
24,000
30,000
36,000

$ 2,496
3,896
5,407
7,040
8,803
10,707
12,764
14,985
17,384
32,583
54,914
87,727
135,940

$ 1,560
2,340
3,120
3,900
4,680
5,460
6,240
7,020
7,800
11,700
15,600
19,500
23,400

$ 1,601
2,464
3,372
4,327
5,332
6,390
7,502
8,672
9,903
17,087
26,343
38,270
53,638

$ 895
1,432
2,035
2,713
3,471
4,317
5,262
6,313
7,481
15,496
28,571
49,457
82,302

The above results are only estimates. They assume an 8% compounded growth rate per year and a 35% marginal income tax bracket. Actual investment results will change the figures accordingly.

These figures also represent only employee elective deferrals. A 50% employer match will increase the 401(k) plan balance substantially. For instance, after five years, a 50% match would result in a balance of $10,560, compared with an accumulated balance of only $4,327 without a plan.

The balances at the end of each year for the 401(k) plan are all before tax. Any withdrawals would be subject to income tax at the time of withdrawal.

An employer match on employee contributions, if any, and any discretionary employer contributions made during an employee's period of participation would increase the ultimate benefit.

What is the Saver’s Credit?

Beginning in 2002, there is a non-refundable tax credit available for low to middle income taxpayers who contribute to the 401(k) plan. The maximum annual contribution available for the credit is $2,000, and the amount you can claim depends on your income (AGI) as follows:

AGI

Single Filer

Joint Filer

Head of Household

Credit

0-15,000

15,000-16,250

16,251-25,000

Over 25,000

0-30,000

30,000-32,500

32,501-50,000

Over 50,000

0-22,500

22,501-24,375

24,376-37,500

Over 37,500

50%

20%

10%

0%

Why start making contributions now?

Because the cost of waiting even one year can be dramatic in terms of the balance on your account at retirement.

$2,400 in Annual Contributions

Starting Age

Value at Age 65

Cost of Waiting
One Year

25
26

35
36

45
46

55
56

$702,070
645,875

299,378
274,095

118,196
106,820

36,677
$31,559

$56,195

25,283

11,376

$5,118

Assumes: $24,000 Annual Income
Married with 2 exemptions
8% interest