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401(k) plans must be sponsored by an employer, typically a private sector corporation, but self employed individuals can set them up also, and previously government entities could too. The employer acts as a plan fiduciary and is responsible for creating and designing the plan as well as selecting and monitoring plan investments. (In practice, nearly all employers outsource all of this work to a brokerage firm or other financial company.)
The employee asks to have a portion of his salary paid directly, or "deferred", into his 401(k) fund. In trustee-directed 401(k) plans, the employer appoints trustees who decide how the plan's assets will be invested. In participant-directed plans (the most common option), the employee can select from a number of investment options, usually an assortment of mutual funds that emphasize stockSee stock (disambiguation) for other meanings of the term stock A stock also referred to as a share is commonly a share of ownership in a joint stock company. The owners and financial backers of a company may desire additional capital to invest in new pros, bondIn finance and economics, a bond or debenture is a debt instrument that obligates the issuer to pay to the bondholder the principal (the original amount of the loan) plus interest. Thus, a bond is essentially an I. I owe you contract) issued by a privates, money marketThe money market is a general term for the markets in which banks lend to and borrow from each other, trade financial instruments such as Certificates of Deposit (CDs) or enter agreements such as Repos and Reverses. The market normally trades in maturitie investments, or some mix of the above. Many companies' 401(k) plans also offer the option to purchase the company's stock. The employee can generally re-allocate his money among these investment choices at any time.
Some companies match employee contributions to some extent, paying extra money into the employee's 401(k) account as an incentive for the employee to save more money for retirement. Alternatively the empoyer may make profit sharing contributions into the 401(k) plan. These contributions may vestIn law vesting is to give an immediately secured right of present or future enjoyment. Basically that means being able to take full advantages of the asset in which one is vested. Typically this term is used in conjunction with a retirement plan such as a over several years as an inducement to the employee to stay with the employer.
When an employee leaves a job, he can generally keep that 401(k) account active for the rest of his life, if desired, though in 20042004 is a leap year starting on Thursday (the link is to a full 2004 calendar), and has also been designated the: International Year of Rice International Year to Commemorate the Struggle against Slavery and its Abolition Elections are to be held in 73 co some companies started charging the portion of the plan fees to ex-employees who maintained their 401(k) account with that company that the employer otherwise would have paid. Alternatively, if the employee takes a new job at a company that also has a 401(k) or other eligible retirement plan, the employee can "roll over" his account into a new 401(k) account hosted by the new employer, or into an IRAIRA is an acronym with various meanings. There are several paramilitary groups which claim the title 'Irish Republican Army', and advocate an all-island Irish state achieved through force with no ties to the United Kingdom. Irish Republican Army (explaini.
The employee does not pay taxA tax is an involuntary fee paid by individuals or businesses to a government. Taxes may be paid in cash or kind (although payments in kind may not always be allowed or classified as taxes in all systems). The means of taxation, and the uses to which thees on the amount of income that he defers to his 401(k) account. For example, a worker who earns $50,000 in a particular year and defers $3,000 into his 401(k) account that year is taxed as though he had earned only $47,000 in that year, ignoring other deductions. In 20042004 is a leap year starting on Thursday (the link is to a full 2004 calendar), and has also been designated the: International Year of Rice International Year to Commemorate the Struggle against Slavery and its Abolition Elections are to be held in 73 co, this would represent a near term $750 savings in taxes for a single worker, assuming he remained in the 25% marginal tax bracket when taking into account other deductions and adjustments.
Furthermore, all earnings from the investments in a 401(k) account are not taxed. The resulting compound interest without taxation can be a major benefit of the 401(k) plan over the years.
The employee finally pays taxes on the money as he withdraws it after his retirement. The taxes are at the "ordinary income" rate, falling into whatever tax bracket the employee is in at the time he withdraws the money. The assumption is often made that the employee will be in a lower tax bracket in retirement, but this assumptionis not always realistic or guaranteed to be correct.
The IRS allows the tax advantage for income deferred into a 401(k), but places the restriction that unless an exception applies, money must be kept in the plan or an equivalent tax deferred plan until the employee reaches 59 1/2 years of age. Money that is withdrawn prior to 59 1/2 is typically assessed with a 10% penalty tax immediately unless a further exception applies.[1] This penalty is of course on top of the "ordinary income" tax that has to be paid on such a withdrawal. The exceptions to the penalty include: the employee being totally and permanently disabled, separation from service in or after the year the employee reached age 55, substantially equal periodic payments under section 72(t), a qualified domestic relations order , and for deductible medical expenses (exceeding the 7.5% floor).
In only the last two of the above cases, it is possible for the employee to withdraw money from the plan before separation from service and avoid the penalty. One more option for withdrawal from a 401(k) while currently employed is a hardship distribution with specific hardship rules applying. Hardship withdrawals are subject to the 10% penalty if made before age 59 1/2. Plans can either offer or not offer many of the above options for withdrawal.
Many plans also allow employees to take loans from their 401(k) to be repaid with after-tax funds at pre-defined interest rates. The interest proceeds then become part of the 401(k) balance. The loan itself is not taxable income nor subject to the 10% penalty as long as it is paid back either before separation from service or immediately upon separation.
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