What is a 401(k) Plan?
Daniel Beckett
Retirement plans in the US include the popular 401(k) plan. The plan is a income tax deferred retirement fund that is funded by employees wages that go straight to the plan. Then, income tax is paid when the employee begins taking the money out of the plan after retirement. This is usually beneficial because the employee is often in a lower tax bracket after retirement than before.
Many employers will match funds deposited by their employees into the 401(k) plan - this is a great benefit that will give an immediate return of 100% at least up to the amount the employer matches. Most employers set a limit as to how much of the deposit they will match. However, matching funds is one of the best features of many 401(k) plans.
Management
The funds of 401(k) plans are usually managed in only two possible ways. One is where there is a trustee who makes all the decisions - the manager or trustee is usually chosen by the employer. The other is the self-directed 401(k) where the employee gets to choose between a number of investment options that are made available to the plan participants.
Getting the Money Out
One of the largest difficulties with a 401(k) is withdrawing funds early. As the entire plan is based off retirement planning, almost all employers who participate in a 401(k) impose strict restrictions on withdrawals. In addition to normal income tax, which must be paid whenever money is withdrawn from a 401(k), an additional 10% tax is levied on top of whatever taxes the employee owes on the money withdrawn.
However, some plans do allow loans from the 401(k) plans if there is some dire need. The loan is not subject to the penalty or the tax, but it must usually be paid back with interest. Planning is important to make sure the employee does not defer wages into a 401(k) plan that the employee is likely to need - taking a loan can be difficult and will cost more than just not depositing the money to begin with.
Moving the Funds Around
With today's workforce being so mobile, it is unusual for an employee to work for one employer for a whole career. 401(k) plans allow for moving to another job, though. The plan can be transferred to an individual retirement account or can be moved straight to the new employer's plan if the new employer has a 401(k) plan.
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