What Is a 401K Plan?

What is a 401k plan? Many workers and employees have heard this term, but many are not very familiar with exactly what a 401k plan is or what it does. A 401k plan is simply a retirement plan that is offered by many employers in the U.S. These plans are named after the IRS section that allows them. A 401k plan offers many benefits, including tax benefits. When contributions are made to this plan they are done on a pre tax basis. Most employees make contributions using a salary deferral that comes out of their paycheck before taxes are figured. No income taxes are owed on 401k contributions until the money is drawn from the account. Money that is contributed to one of these retirement plans will earn interest for the account, and will grow while staying tax deferred.

The 401k plans allow a matching contribution from the employer, up to a specific percentage of the earnings. This can be done several different ways. Some employers will match one hundred percent of the contributions made by the employee up to three or five percent, while other employees may only match a certain percent of employee contributions. The matching contributions may or may not be fully vested when they are made, depending on the specific type of 401k plan the employer uses. Vesting can occur instantly once the contribution is made, or it can occur gradually, such as a certain percent over a certain length of time. Vesting can also be withheld until the employee reaches a specific length of employment, such as three years or five years. A lot of 401k plans follow a twenty percent vestment every year, which means the employee becomes vested in twenty percent of the matching contributions each year for five successive years. With these plans, after the first year the employee is entitled to twenty percent of the matching funds, after the third year the employee is vested for sixty percent of the matching contributions, and after five years the employee is one hundred percent vested in all the funds in the account.

A 401k plan allows an employee to invest in their retirement in many different ways. This can include mutual funds, bond and money markets, guaranteed investment pools, annuities, stock, and other investment types. Almost all 401k plans offer a wide selection of options for investment so that a portfolio can be built that meets the individual employees needs concerning risks and returns. Contributions to a 401k plan can only be withdrawn under certain circumstances, unless a ten percent early withdrawal penalty is paid. The money may be withdrawn when the employment with the sponsored company ends, if the employee has a disability, when the employee reaches a specific age, usually fifty nine and a half years but sometimes as young as fifty five years of age, when the employee retires, or if the employee dies. Any other withdrawal reasons will be assessed the ten percent penalty for early withdrawal. Some 401k plans have allowances for loans against the plan, and if this is the case no penalties will be assessed for loan proceeds withdrawn. These loans must be paid back with interest, but the employee pays interest to their own account, so this also has benefits.

A 401k plan is a retirement plan sponsored by the employer that offers tax deferred savings while allowing interest to be earned on money in the account. These plans are a great way to save for retirement and get the most from the money contributed without substantial risks.

The information supplied in this article is not to be considered as medical advice and is for educational purposes only.