A 401k retirement plan enables those in the workforce to save for retirement by having that savings invested while avoiding taxation until time of withdrawal. Many employers offer matching funds as part of their benefit package.

Self-Directed: What does that Mean?

A Self-Directed 401k is exactly the same as any other 401k except that it allows you to choose precisely how you want to invest your savings. Traditional 401k investments are typically limited to reliable stocks, mutual funds, CDs, bonds, and sometimes company stock. At times, individuals are allowed some choice, but usually only within a finite range of products offered by a certain company. Normally a trustee or manager chooses from this group of more conservative investment choices.

Owners of Self Directed 401k accounts have access to almost unlimited investment options including stocks, bonds, real estate, tax lien certificates, notes, and more. With such a varied selection, participants are more likely to find better performing funds and, therefore, increase their retirement savings.

Of course, as with any financial investment, there are certain risks involved. The participant must become knowledgeable about smart investment practices. Sometimes having more choices makes it more difficult to make a decision. With Self Directed 401k plans, there is definitely an added responsibility on the participant.

Employers worry that their employees will make uneducated investment choices and possibly blame them. As a result, companies have been trying hard to provide education – about the pros and cons of Self Directed 401k plans — to their employees. Also, some employers will only let individuals self direct a certain percentage or monetary amount of their 401k plan.

Guidelines

If you are part of a company that offers Self-Directed 401k options, be sure to follow these important rules:

• Be aware of contribution limits. Just as with a regular 401k plan, you can only put in a certain annual amount. Typically, this limit changes from year to year. In 2008 the maximum monetary contribution was $15, 500 per employee.
• Consider withdrawal rules and associated penalties. Generally, you are not supposed to make withdrawals until retirement. If you do so before that time, you will be subject to penalties including, but not limited to, taxation of the withdrawn amount.
• Do not choose investments that could be labeled “self dealing” or from which you will indirectly benefit. For example, you cannot decide to invest in a company owned by a family member or someone who has a fiduciary interest.
• Ask about any additional costs. Often there is an administrative and/or per transaction fee. Participants are responsible for paying these.
• Take the time to educate yourself about investment strategy. Know the risks and work hard to make sound investment decisions.

Although there is certainly some chance involved in being the owner of a Self Directed 401K, most individuals are thrilled to have the option. Everyone would agree that there is something empowering about being able to manage your own money and make your own financial decisions.

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Your employee-sponsored 401k retirement account is meant to remain untouched until you have reached the age of retirement. However, there are circumstances that arise where a lump sum of cash is needed for an emergency and 401k funds are the only resource available. Funds withdrawn from a 401k account early are subjected to a ten percent penalty fee in addition to the taxes assessed on the amount by the IRS but there are ways to access your 401k fund without incurring a penalty.

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401k Loan

In hardship situations, the federal government gives administrators of retirement plans the ability to offer 401k loans. Not all providers will offer such loans but if you are in need of cash, you can inquire with your provider. Loans can be used for a number of reasons and the government does not have guidelines for how the money is used, though some employers will restrict what the funds can be used for and how much can be taken out.

Generally, a loan in the amount of up to 50% of their vested balance with a maximum loan amount of $50,000. The loan must then be paid back with interest within a 5 year time period. If the borrowed cash is towards the purchase of a home, the payback time granted is much longer.

401k Hardship Withdrawal

If you are not eligible for a 401k loan, you may still be able to access your retirement funds when you have a genuine need. Not all employers will offer such hardship withdrawals so you’ll need to check in with your plan’s provider to find out the terms for hardship conditions.

Typically, there are four conditions that must be met in order to qualify for a penalty-free hardship withdrawal including:

1. The withdrawal is necessary because of a serious, immediate financial need.
2. The withdrawal is necessary because you do not have access to money from any other resource.
3. The withdrawal amount does not exceed the total amount of money you need.
4. Borrower has already received all distributable or non-taxable loans associated with your 401k retirement plan.

Steps to Cash in 401k Penalty Free

If you are in serious need of withdrawing funds from your 401k retirement account because you have exhausted all other resources, consult with the administrator of your plan to understand your options as all plans differ in terms and conditions by provider.

For many people, it is possible to borrow against your 401k retirement account. Just because it’s possible, doesn’t make it the best option for everyone. When you borrow from a 401k plan, you end up repaying yourself, plus interest – but it’s not quite as simple as that sounds.

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Basic 401K Loan Borrowing Rules

Each plan has slightly different rules as they are managed by the plan administrator – usually your employer.

Most 401k plans allow for loans. You must first check with your plan administrator to see if the plan allows loans – if they do not, you will not be able to borrow from your account. If they allow loans, then you can borrow up to 50% of your total account balance or $50,000 (whichever amount is less).

For most 401k loans, there is a maximum of five years to repay the loans, unless you use the money to pay for your first house, in which case the plan will allow a longer repayment term.

There are no credit checks to qualify for a 401k loan. There is no “application” process like there is when you go to a bank or credit union for money. The money is yours, and although it’s meant to be used for retirement, if the fund allows for 401k loans, you can take one if that’s what you choose to do.

The plan will set the interest rate, which is almost always lower than an interest rate you pay to a bank or credit union. The interest you pay is usually a couple percentage points more than the prime rate.

Unlike a “hardship withdrawal”, which requires certain financial situations to qualify and charges a 10% penalty as an early distribution of your retirement fund – a 401k loan does not charge a penalty since you will be paying it back.

Why You Should Think Twice Before Borrowing from a 401K

While it seems like borrowing money from a 401k plan is a great way to get some cash when you need it, there are a number of reasons to think twice before signing your name on the dotted line.

It’s true that you’re borrowing money and paying yourself back with interest – but it’s also true that you have less money in your fund to invest and earn interest. The money taken out for your loan is no longer appreciating in value and you miss out the benefits of compounding interest.

Once you start making payments to your 401k for a loan, the payments are made with after-tax dollars. When you take the money out again in retirement, you’ll have to pay taxes on the money again. When you contribute to a 401k normally, the money goes in before taxes are taken out, and the taxes are paid when you withdraw the money during retirement.

Once you start taking loans from your 401k, your frame of mine about saving for retirement changes. The point of retirement plans like a 401k is to save the money until you are ready to retire. The more frequently you take money from the account, the less you will have when you retire.

Individuals who use a 401k to save for retirement must understand how their plan works in order to get the most benefits offered by this type of savings plan. How you manage your 401k from the beginning will prove to be important when the time comes to withdrawal money from your account. Here we look at how the 401k works and tips to manage your account up to the point of retirement.

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What is a 401k?

The 401k is a savings plan made available by employers. Employees can contribute to their 401k with pre-tax dollars allowing the money to grow in a tax deferred setting. Contributions can usually be used as a tax deduction when you file your income tax return. Employers also have the option of contributing or matching your contributions. The 401k is designed as a long term savings plan and is set up in a way that discourages early use of the monies in that account. When managed properly and as intended, you won’t touch money in your 401k until retirement. When that time comes, how you manage your 401k becomes even more important to ensure you have enough money to last throughout your golden years.

Tips before retirement.

• Start planning for your retirement before it is actually time to retire. You have probably been planning your retirement for years, however it isn’t until the actual day arrives that many people consider what they will actually do once they are no longer working. Having worked an entire lifetime to save for retirement means you must take certain steps once you reach retirement to ensure your money is going to last the duration. Approximately one year before retirement you should take a good, long look at your portfolio to determine if you have enough assets to last throughout your retirement. By checking this information in advance you can avoid retiring too early with not enough money put aside to last through the years.
• Talk to a professional if you have any questions. You may have been working with a financial planner throughout your career or perhaps you are just now considering getting expert advice. A financial expert can review your situation and offer unbiased, expert advice regarding how you should proceed moving forward.
• Determine how much money you will need to live and how much money you have coming in. Include in you available income the following; Social Security benefits, pensions, 401k distributions and any other income from investments or other retirement plans. When calculating your expenses, ask yourself how much you will need for housing, clothing, food, utilities, hobbies and other expenses. This should help you determine your retirement budget and see if you will have enough money to pay for all expenses.
• Take distributions as determined by your plan- Avoid taking early distributions and be sure to take mandatory minimum distributions per your plan. This will ensure you get the most benefit from your money and avoid paying more to the IRS than necessary.

Last Minute Retirement Tips

There are many things to consider when the time comes to exit the workforce. After saving for most of your adult life, it is very important to take the necessary steps to protect your retirement savings and ensure they are used as intended. Your 401k is an integral piece of your retirement plan, so that’s why you need to go great lengths to implement some of these tips.

Ifyou’re laid off, what happens to your retirement money?  Well, you have three basic choices with your 401(k). One gives you more freedom and control than the other two.

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You could just leave your 401(k) alone.

The money will remain invested, and the financial firm handling your 401(k) will keep mailing you quarterly statements telling you how it is doing. Any future growth will be tax-deferred.

But this passive choice comes with an opportunity cost. If you just leave the 401(k) assets in the plan, you’re giving up control and flexibility. Your investment choices may be limited, the plan fees may be high, and you may not be able to quickly access your money or do what you want with it. If you have a trail of old 401(k)s left with a bunch of former employers, things can get really complicated when you retire – especially when you have to take Required Minimum Distributions (RMDs). Leaving the money in the plan may not be the wisest choice.

You could withdraw the money.

This is a terrible choice – a last resort. It comes with a severe financial penalty. You will not get all the money you have invested back – far from it. You will lose 20% of your 401(k) assets to withholding taxes, and if you are under 55, the IRS will levy an additional 10% penalty for early withdrawal of the assets. By the way, distributions from a 401(k) are considered taxable income – so expect a big tax bill in the year you cash out. The federal government does not want to see you wipe out your retirement savings. Neither does your financial advisor. (If you really need money, you could consider borrowing from your 401(k). The problem here is that most companies want the loan balance paid off when you leave – whether you leave work by choice or not.)

You could roll it over into an IRA.

This is the choice that usually makes the most sense. You can move the money into an IRA through a rollover or trustee-to-trustee transfer. Or, you could direct the money into a so-called “conduit IRA,” a traditional IRA created to hold your old 401(k) assets until you move the money into another qualified retirement plan. (You can’t contribute to a conduit IRA.) There’s no tax penalty when you do an IRA rollover or trustee-to-trustee transfer. After you do it, you have total control of the money, continued tax-deferred growth, expanded investment choices, and possibly lower management fees.

Rolling over the money into a Roth IRA might be a great move, provided you can meet two conditions. First, your adjusted gross income has to be less than $100,000 for the year in which you make the rollover. Second, you’ll have to pay taxes on the assets you convert. The upside is considerable: you get tax-free compounding, tax-free withdrawals if you are older than age 59½ and have owned your account for at least five years, and the potential to make contributions to your IRA after age 70½ without having to take RMDs. Contributions to a Roth IRA are not tax-deductible, but there are fewer restrictions on withdrawals.

In 2009, you can fund a Roth IRA with after-tax contributions to a 401(k), 403(b) or 457 retirement savings plan – you can take those contributions and convert them to a Roth IRA tax-free, provided your AGI is $100,000 or lower. There is no limit on the conversion amount. Incidentally, in 2010, anyone can convert a traditional IRA to a Roth IRA – the AGI restriction on such conversions disappears.

If you need to open an IRA, consider or Zecco.

What if you have to shiver through a 401(k) freeze?

A “freeze” is when your employer reduces or suspends matching contributions to your retirement plan. FedEx, General Motors and Motorola have all recently chosen to do this. The answer: don’t let up on your personal contributions. If you can manage it, adjust your 401(k) contribution to a level where you effectively replace what your employer contributed. Saving for retirement should remain one of your highest priorities.

How is your money positioned? How are you invested today? Are you doing things designed to preserve and enhance your retirement money?

When it comes to 401(k), what are your best options? There’s a ton of information out there that could confuse a Harvard graduate and the landscape is forever changing.

In the past year or so, we’ve seen some interesting options emerge for 401(k) account holders … “new wrinkles” that everyone with a 401(k) should be aware of, regardless of whether you’re contributing $50 a month or the maximum of $16,500 per year ($22,000 per year if you are 50 or older).

New help for do-it-yourselfers.

As a result of the 2006 Pension Protection Act, you can now get advice on managing your 401(k). You can get it online from the financial company overseeing your account, or from the financial advisor who helped you set up your account. Previously, employers refrained from connecting employees to professional management and advice – they didn’t want to be held responsible if an employee lost money. Under the new Pension Protection Act, they won’t be.

The new Roth 401(k)s.

New in 2006, here through at least 2010 and likely to stay, the Roth 401(k) combines features of the traditional 401(k) with those of the Roth IRA. The contributions come from after-tax dollars, the account grows tax-free, and you get income tax-free withdrawals during retirement (provided you’re at least 59 ½ and have had your account for at least five years).

Professionally managed 401(k)s.

You can now ask to have your 401(k) directed by a money manager, if your plan is serviced by one of the big investment firms such as Fidelity, Charles Schwab and others. Your money manager will rebalance the investment mix of your 401(k) in order to manage risk.

“Autopilot” 401(k)s.

Even if investing scares you, companies can now automatically enroll you in a 401(k) as soon they hire you. An in-house employee benefits manager may pick the investment mix and contribution level for you if you decline to do so.

If you’re not sure which of these options is best for you, consider speaking with a professional who can help to guide you.