What is a 401(k) Plan?

Don’t let the cryptic name of the plan confuse you, these plans are
actually fairly easy to understand. A 401(k) is a retirement plan
offered by some employers in the United States. The plan received the
name from the section of Internal Revenue Code it was named after.

Tax Benefits

One of the largest benefits of a 401(k) plan is how contributions
are made on a pre-tax basis. As an employee, you are allowed to make
pre-tax contributions through salary deferral into the plan. Since
these contributions are done on a pre-tax basis, you do not pay any
current income tax on the money that is deferred into the plan.

In addition to reducing your tax liability through contributions,
the money that is saved in the plan can earn interest and continue to
grow tax-deferred. You are only taxed on the money you withdraw from
the plan at a later date as ordinary income.

The Employer Match

Some companies offer an additional benefit in these plans in the
form of a company match. This means your employer will contribute
additional money into your plan that matches a portion of your
contributions. Some employers match dollar-for-dollar up to a certain
percentage of pay while others match a specified percentage of your
contribution.

In addition, the company may have a vesting schedule in place that
requires you to work for the company for a given length of time before
you can collect the matched money. The vesting period can be on a
graduated scale or a one-time length of service requirement.

Investment Choices

A 401(k) plan allows you to invest money for retirement in a number
of ways. These may include mutual funds that invest in the stock, bond
or money markets, annuities or guaranteed investment pools, company
stock or even self-directed brokerage accounts. Most plans will offer a
selection of various investment options that will allow you to create a
suitable retirement portfolio.

Withdrawals

Money can generally be withdrawn from a 401(k) on five different occasions:

• Termination of employment
  
• Disability
  
• Reaching age 59 ½ (or 55 in some cases)
  
• Retirement
  
• Death

It is important to note that in some cases if money is withdrawn
from these accounts before reaching age 59 ½ the IRS will issue a 10%
early withdrawal penalty. Outside of the five qualified distribution
events you may be able to access a portion of your money if your plan
allows loans.