Corporate 401(k) Plans
A 401(k) plan is a type of retirement savings plan that is funded by
employee contributions, and often matching contributions from the
employer. In the United States, the 401(k) plan allows a worker to save
for retirement and have the savings invested, while also deferring
current income taxes on the saved money and earnings until withdrawal.
The employee elects to have a portion of his or her wages paid directly,
or deferred, into their 401(k) account. Rules and regulations for 401(k)
plans are established by the U.S. tax code. In fact, the 401(k) plan
takes its name from the section of the Internal Revenue Code of 1978
that created the plan.
As an employee benefit, a 401(k) plan must be sponsored by an employer
or tax-exempt non-profit organization for its employees. In addition, a
self-employed individual may also set up a 401(k) plan.
Most 401(k) plan contributions are on a pre-tax basis. For these pre-tax
contributions, the employee does not pay federal income tax on the
amount of income he or she defers into the 401(k) account. For example,
a worker who earns $50,000 in a particular year and defers $3,000 into
their 401(k) plan for that year only recognizes $47,000 in income on
that year’s tax return.
There is, however, a limit on contributions that may be made into an
individual’s 401(k) plan each year. In 2009 and 2010, that maximum limit
is $16,500 for employees age 49 and under, and $22,000 for employees age
50 and over. If an individual has more than one 401(k) plan, they must
adhere to this maximum contribution limit as a total in ALL of his or
her 401(k) plans.
With rare exceptions, all withdrawals from 401(k) plans are taxable as
ordinary income. A 10% penalty will be assessed if the employee has not
reached at least age 59 ½.
