A Quick Introduction To What Is A 401k Plan

Article Written By: RebbecaMyers

401k plans were created in 1981, by the United States Congress, to provide a simple vehicle for retirement savings. Many people, however, still wonder, specifically, what it is. It allows employees to enjoy tax advantages, employer matching funds, investment allocation, and portability. Many employers even allow employees to borrow money from 401ks, charging minimal interest, and no penalty, for hardships or major purchases.

Employees fund their 401ks through payroll deductions, taken out pre-tax. If investments in the retirement account accrue capital gains, dividends, or interest, the funds will compound inside the account, tax-free. Also, because pre-tax payroll deductions mean less taxable income, employees may even be dropped into a lower tax bracket, because of their contributions. Until employees withdraw funds from their accounts, no taxes are charged for any of the funds.

Employers often provide matching funds for employee contributions. Employers sometimes match a percentage of employee money, or they sometimes match the entire employee contribution, dollar for dollar. The first six percent of employer matching contributions, based on the employee's pre-tax salary, are not figured into the annual contribution limit.

If you are self employed you can even take advantage of what is called a solo 401k plan. These were recently introduced by congress to allow those contributors the same benefits as the employed counterparts. This allows these investors to put a lot more away when compared to a traditional retirement plan, like an IRA.

401ks give employees the freedom to select their own investment mix. Employees may allocate their assets based on their age, and on their risk tolerance. For example, older employees with less risk tolerance may choose to hold more cash or bonds, as opposed to a younger employee with a greater tolerance for risk. Many employers offer discounted company stock to participants, but employees should be careful about purchasing too much of their company's stock. If something happens to the company, then a large portion of the investment portfolio will be reduced in value.

When employees switch employers, they may roll over their 401ks. 401ks may be rolled over into the new employer's retirement plan, or into a separate IRA. Rolling over it allows capital to accrue undisturbed, to build up the maximum tax-deferred retirement income. Also, rollovers give employees continued control over their investment mix.

Many employers allow employees to borrow from 401ks. Rules vary according to the plan administrator, but employees may usually borrow up to one-half of their vested balance, with a maximum of $50000. Interest will be charged for loans, but the rates are usually low. Also, payback terms vary, but most plans require loans to be paid back within five years.

With few exceptions, early withdrawals out of 401ks are hit hard by penalties and taxes. If money is withdrawn before age 59 1/2, employees will have to pay taxes, along with a 10% penalty. Early withdrawals mean a hefty loss of cash, but the most significant loss is the loss of compounded retirement savings, which would have accrued if money was left alone.

In 2011, the federal annual contribution limit is $16,500. If allowed by their employers, employees older than fifty years of age may make catch-up contributions, not to exceed $5,500. With all of the tax advantages that they offer, in addition to free employer matching funds, 401ks make smart retirement vehicles.

About the Author

For additional information on what is a 401k plan you may stop by the site. You will find similar subjects looked at such as solo 401k plan and quite a bit more when it comes to money related topics.

You Can Link Directly to "A Quick Introduction To What Is A 401k Plan" by using the url:
http://www.allbestarticles.com//finance/retirement-planning/a-quick-introduction-to-what-is-a-401k-plan.html

This Article Has Been Published on Mon, 22 Aug 2011 and Read 118 Times

Find All Best Articles at http://www.allbestarticles.com

Rating: Not yet rated

Comments

No comments posted.

Add Comment

You do not have permission to comment. If you log in, you may be able to comment.

Related information on Retirement Planning

What Is An Individual Retirement Account
Simple IRA Rules For Small Businesses
What Is An IRA Retirement Account
A Quick Introduction To What Is A 401k Plan
Why are more consumers opting for an annuity account to save cash?
Reasons Why You Should Start Saving for Your Retirement NOW!
Find the Right Retirement Job