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Innovative Employees' Solutions

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Abstract

A 401(K) plan is a retirement plan that is funded with pre tax payroll deductions. The obtained in this account funds are invested in various stocks; some can go to bonds, mutual funds as well as other assets till their withdrawal. This retirement plan formed by congress in 1981 derives its name from the internal revenue code that describes it as section 401k. The popular press and politicians generally describe 401(k) retirement plan as a problem; the economists have an entirely different view. In this research paper we will see how the 401(k) retirement plan is not only a problem but also an improvement. It has both advantages and disadvantages that should be taken into consideration before any employee or employer should consider signing up for such a retirement plan. The method used in this research is analyzing empirical resources and giving findings. In this research I found out that 401(k) retirement plan has both negative and positive impacts on workforce that eventually neutralize each other.

Introduction

The 401k retirement plan is named after a section of the tax code with the paragraph k. According to this plan an individual makes regular contributions to a retirement account that he owns. It is different from common pension plans which result in giving an individual a modest sum upon retirement. This plan enables the holder of the account to make his own investment decisions, consult or hire a professional to make investment decisions (Kennon 2012). The 401k retirement plan has become a popular scheme since a traditional pension plan is costly for many companies. According to the 401k plan, an employee decides on the amount of money he wants to contribute and he can contribute money that has not been taxed yet which reduces his taxable income. Then the amount that the employee has contributed is added to company funds and the money in retirement accounts is tax-deferred.

Research methodology

Search methodology involves gathering relevant data from various sources and websites in order to analyze the obtained information. It allows to summarizing specific findings and forming a concrete conclusion.

The economics of 401(k)

The existence of 401k retirement plan has raised several economic questions among most employees. Several questions have been asked about economic concept and effectiveness of this plan. For example; when do borrowing costs of 401k loans reduce as compared to other sources of liquidity? How do 401(k) loans affect general wealth accumulation of retirement? How do 401(k) loans affect prosperity of individuals? These are questions that have been raised when the 401(k) plan came into action.

Disadvantages of the 401(k) retirement plan

An individual who reads articles and journals about 401(k) concurs that there is no consensus regarding the above questions.  Articles and websites such as “401(k) loans are hazardous to your wealth and robbing tomorrow to pay for today” argue that loans from 401(k) are a terrible idea, that no employee should consider it. These articles have listed a number of drawbacks of the retirement plan. The articles clearly show how the retirement plan affects the dollar cost averaging process and significantly lowers long term results (Weller, 2012). Another drawback cited is the idea of stability in terms of employment; when an employee quits or is fired, he has to pay the loan in full mostly within sixty days.  Money in 401(k) retirement plan is not insured, and therefore there is a probability of losing money in the process that cannot be refunded. Some employers limit the amount of contributions made by their employees, this may limit investment return and, finally, the 401(k) retirement plan may not be the best since returns may be very minimal. Individuals who may benefit greatly from this plan are those who invest in risky investments, which have 50/50 chance; this is not a good option for an employee who is not financially secure.

Recent studies such as Weller and Wenger’s (2008) claim that 401(k) loans reduce an individual’s wealth accumulation by at least 22% by the time one retires. In their study Weller and Wenger further assert that the 401(k) plan has more downsides than upsides. They comment that borrowed money do not bring any investment returns. They argue that the 401(k) plan does not cater for an employee’s future interest; it is rather a scheme to reduce an individual’s wealth accumulation.

Types of the 401(k) retirement plan

Some of the contributors propose three types of 401(k) plan. According to The traditional type the employer makes payments on behalf of all employees who have enrolled in the plan. The safe harbor type involves a mandatory contribution of the employer which is invested and matches a percentage contribution for all of employees. The third and the last type is the full flex plan: the employer can determine the amount of contributions he makes per year. He is the one who determines whether it should be obtained through sharing of profits, or matching the employees’ contribution, or a fixed sum of money.

Benefits of 401(k) retirement plan.

In contrast, some commentators of this plan have written about benefits of accepting such a plan. They claim that one does not have to worry about their future when they retire, some go ahead and state that when one has a 401(k) plan, they have a tax advantage as their taxable income is reduced since one contributes money before income is taxed. An interview with Matthew D. Hutcheson by Elizabeth M. Rice reveals benefits of enrolling in the 401(k) plan. He explains how in this retirement plan an employer makes contributions on behalf of all participants. Mr. Hutcheson reveals in his interview that the retirement plan is not only for an employee’s benefit but rather an economic security.

 He explains how an employer equips an employee with a tool to retire in comfort; employees have disposable income to spend on the society and keep the economy working. It is an important aspect that should be considered by all employers in order to improve the economy as well as have a satisfied staff that work well without having to worry about unknown future. It is a good strategy for both the employees and the society in terms of the economy.

Employers match 401(k) retirement plans

The aim of employers is to attract talented employees to the organization. The percentage of matching solely depends on the organization. Starbucks, for example, matches 4% of what their employees contribute to their retirement plans. Employees that have stayed in the company less than 36 months receive a 255 match while those who have been in the company for from 36 to 60 months receive a 50% match.

Flexibility in terms of investment

The retirement plan offers an employee investment flexibility. An individual is able to make his own decisions regarding investments. In other cases, the individual can even hire a professional to make investment decisions or advise the way forward. It is evident from the articles above that the topic of 401(k) is a controversial one as some of the articles relay a positive message about the retirement plan while others asses it negatively.

Impacts of the 401(k) retirement plan on an individual and/ or current workforce

When an organization replaces the old pension plan with the 401(K) retirement plan it may not make a difference for young staff. However, for the employees who are in their 50s and 60s should feel satisfied. The young employees have to double their efforts to generate a sustainable personal savings according their retirement plans. The old tenured workers have the adverse effects than those workers who are young (Rice, 2012). It happens because the old pension plans are back loaded and they accrue more when they are old. The 401(k) plan is even worse; the old employees do not have enough time to produce contributions that will offset their pension losses.

A survey of Watson and Wyatt reveals that the retired employees need about 75% of income they used to earn to survive after retirement. With this in mind, it is impossible for the old workers to obtain such a contribution in a short period; finally the 401(K) plan affects the old workers in a very negative way. Studies have shown that the 401k retirement plan have a major impact on housing wealth of individuals. The retirement plan might successfully replace housing equity wealth in the future.

Effect on savings of individuals

Behavioral effects on match rates

Matching produces huge incentives for contribution. However, matching and savings do not have data that ties them together. Matching of employers creates a great distortion of savings behavior of employees. Most of the sources suggest that the 401(k) plan makes an individual to consume more today what could be otherwise consumed in the future and therefore reduce savings. Finally, 401(K) plans allows individuals to have more personal savings due to tax advantages  people in the workforce have an immense advantage since it enables them to follow  a long term plan for saving (Engen, 2010)  Altogether, 401(K) retirement plan has a positive impact on people’s savings and might lead to a massive 17% increment of personal savings.

Help in investment decisions

The 401(K) plan makes individuals more informed about investment decisions since the decision to invest lies entirely on them. With the help of this retirement plan the individual is be able to seek professional help for the best ways to best invest and get good returns.

Improve saving culture in individuals with no self control

The retirement plan also has an effect on individuals that have self control problems. Such individuals who do not save under normal circumstances may be able to save for the future due to of the 401(K) plan.

Conclusion

This paper has examined comments expressed in articles about 401(K) retirement plan and its impacts on the workforce.  Employers invented the pension plan to manage and retain the workforce; the old pension plan has been there for decades but with time proved to be very costly. This led to the invention of retirement plans such as 401(K) according to which the employee is required to make contributions. There has been a lot of debate regarding this type of retirement plan that has its advantages and disadvantages. It is for the individual to decide whether the retirement plan will be good for him or not. The retirement plans have long-term aspects and employers should examine retirement plans to achieve a balance between managing the workforce and pension risks. It is advisable for employers to be cautious and have a plan to ensure workforce’s best interests.

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