How Do 401ks Work?

[Admiral Yi]

I know that the contributions, dividends, and capital gains are tax free.  I know that sometimes an employer can kick some cash in, but that's not a requirement.  Mostly I'm curious how much choice over investments the employee has.  Are you given a list of approved mutual funds by the employer? 

I must have read 12 articles in various sources on 401ks in the last week but I've never had one so I'm curious.  Curious if all the 59 year olds featured in these articles who just lost 40% of the value of their life savings did so because they overloaded on equities or because they had no choice.

[alfred russel]

I know that the contributions, dividends, and capital gains are tax free.  I know that sometimes an employer can kick some cash in, but that's not a requirement.  Mostly I'm curious how much choice over investments the employee has.  Are you given a list of approved mutual funds by the employer? 

I must have read 12 articles in various sources on 401ks in the last week but I've never had one so I'm curious.  Curious if all the 59 year olds featured in these articles who just lost 40% of the value of their life savings did so because they overloaded on equities or because they had no choice.

You are. At least the plans I've seen have about 10 choices, with at least one money market option, a safe bond fund of some sort, and one indexed equity fund. You usually have an option for a company stock fund, with the company match sometimes paid entirely in company stock.

I was speaking to a woman at my company that has been around 10-15 years and she told me that until recently she was putting all of her 401k money into the company stock fund. The stock has performed very poorly: I'd guess she is down 50%+ of her contribution basis (maybe as high as 75%). She didn't make a very good decision, but it is still unfortunate that she was diligent saving for all those years and now isn't going to have as much as she should for retirement.

[Admiral Yi]

You're a prince Fredo.  Couple more questions if you're in the mood.

A 401k employee is stuck with those 10 choices until they leave the company?  What happens then? 

Also, do IRA withdrawals get treated as regular income?  You're not on the hook for all accumulated capital gains are you?

[alfred russel]

You're a prince Fredo.  Couple more questions if you're in the mood.

A 401k employee is stuck with those 10 choices until they leave the company?  What happens then? 

Also, do IRA withdrawals get treated as regular income?  You're not on the hook for all accumulated capital gains are you?

It depends, the employer may let you stay in the 401k plan, in which case you are still limited, but you can roll the plan into an IRA, which is probably a better choice as there you can invest in whatever you want.

In a 401k or IRA, because you aren't taxed on the income going in, your tax basis is zero. There are no capital gains either: any distribution from a 401k or IRA is ordinary income. If you invest in stocks that have a lot of appreciation in a 401k or IRA, you could be hurt by putting them in the 401k or IRA as stock is tax deferred anyway and you lose the capital gain treatment.

There is a special case for 401k funds in company stock, which are eligible for capital gains treatment, but I believe that is the only exception.

[Admiral Yi]

If you invest in stocks that have a lot of appreciation in a 401k or IRA, you could be hurt by putting them in the 401k or IRA as stock is tax deferred anyway and you lose the capital gain treatment.

This I don't understand.  But you're still a prince.

[alfred russel]

If you invest in stocks that have a lot of appreciation in a 401k or IRA, you could be hurt by putting them in the 401k or IRA as stock is tax deferred anyway and you lose the capital gain treatment.

This I don't understand.  But you're still a prince.

The real key is if your tax rate goes up. I should have added that in there.

[Baron von Schtinkenbutt]

I was speaking to a woman at my company that has been around 10-15 years and she told me that until recently she was putting all of her 401k money into the company stock fund. The stock has performed very poorly: I'd guess she is down 50%+ of her contribution basis (maybe as high as 75%). She didn't make a very good decision, but it is still unfortunate that she was diligent saving for all those years and now isn't going to have as much as she should for retirement.

Some plans limit the percentage of the portfolio that can be put into particular, higher-risk investments.  In particular, my plan restricts investment in the company stock fund to 10% of my total portfolio.

Oh, and we have 45 options.

[Admiral Yi]

Oh, and we have 45 options.

Same basic mix as Fredos?

[Baron von Schtinkenbutt]

Oh, and we have 45 options.

Same basic mix as Fredos?

Its all mutual funds, and its a broad selection.  We've got two index funds, two fixed income funds, two government bond funds, funds classified as large cap, mod cap, and small cap, about a dozen specialized funds (these are the ones with restricted investment allocations), and (since this is Fidelity) 8 Fidelity Freedom funds.

[alfred russel]

Some plans limit the percentage of the portfolio that can be put into particular, higher-risk investments.  In particular, my plan restricts investment in the company stock fund to 10% of my total portfolio.

I don't care for nanny state restrictions. We have limits on contribution percentages, which can be really annoying if you want to max out your 401k but don't want to contribute evenly throughout the year.

Oh, and we have 45 options.

I glad your company provides a better 401k plan, considering you probably can't sleep at night due to all the third world deaths your work contributes to. :p

[Baron von Schtinkenbutt]

I don't care for nanny state restrictions. We have limits on contribution percentages, which can be really annoying if you want to max out your 401k but don't want to contribute evenly throughout the year.

We technically have a contribution limit, but practically its so high (50%) you can contribute as much as you want until you hit the IRS annual limit, at which point you can keep going after-tax if you really want to.

I glad your company provides a better 401k plan, considering you probably can't sleep at night due to all the third world deaths your work contributes to. :p

Actually, I'm losing sleep over the difficulty in offloading my condo and the debt I'm building up because of it.

[Iormlund]

You can always program a Tomahawk to "accidentally" veer off and hit your condo.

[Grey Fox]

Right now, in my hand, I hold a Raytheon chip.

Does it works like the All Spark? Turns anything into a weapon?

[Iormlund]

The other way around, I think. The All Scrap.

[Caliga]

I glad your company provides a better 401k plan, considering you probably can't sleep at night due to all the third world deaths your work contributes to. :p

Don't mess with Texas.