Pre-Tax Salary Deferral Plans
Pre-Tax Salary Deferral Plans are designed to help minimize or — in some instances — eliminate the federal taxes due on income received or on wages paid.
How They Work
Participants set aside money for retirement on a pre-tax basis through a salary reduction agreement with the employer. Within the limits established by law, no federal income taxes are withheld from the amount of the contribution. Participants may select from among various vendors offered by the employer when deciding where the money is to be invested. The money grows tax-deferred until withdrawn.
Following are some of the benefits that may accrue to both the employer and employee through the implementation of tax-deferred plans:
By contributing on a pre-tax basis, participants in a tax-deferred plan may greatly reduce their current tax bill.
Generally, a contribution of $100 monthly to a tax-deferred plan may reduce one's current federal tax bill by $25 — assuming the participant is in a 25% tax bracket.
In essence, the participant is buying $100 for $75. It must be noted that this illustration does not take into consideration the participant's filing status, dependents and deductions. It should also be noted that the tax-deferred savings significantly increase as the amount of the contribution increases.
Earnings Are Tax Deferred
One of the greatest single advantages of participating in a tax-deferred plan is that all dividends, interest, capital gains and growth accumulate on a tax-deferred basis while the money remains in the account. This can translate into more dollars working for the participant which, in turn, may lead to larger growth potential.
Taxes must be paid upon withdrawal of any deducted contributions plus earnings and on the earnings from your non-deducted contributions. Tax penalties and penalties for early withdrawal may apply if funds are withdrawn prior to age 59 ½.
Through systematic payroll contributions, the employee may develop a strong investment discipline. Investing becomes automatic, makes saving for retirement easy and eliminates the temptation to skip a contribution. Participants are less likely to miss the money once the first contribution is deducted.
Another benefit derived from an automatic savings program is the application of the "dollar cost averaging" concept that provides the investor with a hedge against market and share-price fluctuations. We emphasize, however, that a plan of regular investing does not assure a profit or protect against a loss during a declining market.
Many tax-deferred plans have a loan provision that enables participants to borrow money from their account. Loans are not treated as distributions (withdrawals) and, therefore, are not subject to federal taxes and penalties. Of course, failure to repay the loan within the terms of the loan may result in the payment of current taxes and penalties.
For 50 years, Lincoln Investment has specialized in offering tax-deferred plans to both employers and their employees.