What Is a 401(k) Plan?

1 What Is a 401(k) Plan?

401(k) refers to a section of the Internal Revenue Service tax code. The code allows employers to sponsor a cash or deferred investment plan for employees. Employees may contribute to a 401(k) plan sponsored by their employer. Depending upon how the plan is set up, various investment options may be available for employees. The employer may also choose to match a percentage of the employee contribution. The investment opportunities that a 401(k) plan offers may have tax benefits for employees. Employees may be able to defer taxes on contributions. The employer may also benefit from sponsoring a 401(k) plan. If an employer chooses to match contributions or a portion of contributions, the employer’s match reduces the tax liability for the employer. Employer and employee contributions may be made through the employer’s payroll system. 

2 Can Changes Be Made to My Contribution Amounts?

The amount you contribute to your 401(k) can be increased or decreased, but there may only be specific times when changes are allowed. You can stop making contributions at any time.

3 Am I Allowed to Withdraw My Money from My 401(k)?

Regular penalty-free withdrawals can be made in the following instances:

· If you have a qualifying disability
· If you reach retirement age
· If the plan is terminated

If you make a withdrawal before you are 59-1/2, or without meeting any of the other requirements, you will pay a 10 percent penalty on the amount withdrawn, and you may pay taxes on the amount withdrawn as well. Your beneficiary or beneficiaries may also withdraw money in the event of your death.If you terminate employment, you can avoid early withdrawal penalties by immediately rolling over your 401(k) into another 401(k) or into an IRA.

4 What Are the Different Types of 401(k) Plans?

· The regular 401(k) allows pretax contributions. Contributions and earnings are taxed upon withdrawal.
· The Roth 401(k) is much like a Roth IRA. Contributions are made after taxes are taken out, but contributions and all the earnings from those contributions are tax free upon qualified withdrawal. Because the 401(k) annual contribution limits have normally been much higher than the IRA contribution limits, you have the potential to accumulate a large amount of tax free contributions and earnings in a Roth 401(k).
Your employer may offer one or both types of 401(k)s.

5 How Much Can I Contribute to My 401(k) Annually?

You may contribute part of or the entire contribution limit per year. This limit may vary annually. Check with your plan sponsor or a tax advisor for current annual contribution limits to 401(k) plans.

6 Can I Take a Loan Against the Balance in My 401(k)?

You may be able to take a loan against your 401(k). Check with your plan sponsor for eligibility and details. If so, you will be required to pay back the amount, with interest. If you fail to pay back the loan, the amount you took would be treated as an early withdrawal, and you would be subject to a 10% early withdrawal penalty as well as any taxes due.

7 How Do I Find out Whether My Employer Offers a 401(k) Plan, and the Details of the Plan?

Your company’s human resources department should be able to provide you with the details of your company 401(k) plan.

8 How Much Should I Contribute to the Plan?

Keep your current financial situation and your plans for retirement in mind when deciding how much to contribute. It may be a good idea to contribute as much as you can afford. If you can max out your 401(k) each year, you will make great strides toward saving for retirement. If you are a younger investor, time is on your side and your funds will have more time to grow until retirement. If your employer offers a match of a percentage of your contribution, contribute at least enough to get the entire matching amount from your employer. This is essentially “free money” for you.

9 How Is the Money in a 401(k) Program Invested?

Your employer determines how your contributions will be invested when the employer sets up the plan. You may or may not have a choice of funds to choose from within the plan. Investment options may range from conservative to more aggressive.

10 Where Can I Learn More about 401(k)s?

Here are a few of many resources that cover 401(k)s:

• Internal Revenue Service 401(k) Resource Guide: http://www.irs.gov/retirement/article/0,,id=151752,00.html
• FINRA (Financial Industry Regulatory Authority) – Smart 401(k) Investing: http://apps.finra.org/Investor_Information/Smart/401k/000100.asp
• CNN Money Magazine’s Guide to 401(k)s: http://money.cnn.com/magazines/moneymag/money101/lesson23/