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A 401(k) plan is one of a variety of employer-sponsored retirement plans. The funds transferred directly from wages into the 401(k) are generally tax deferred, meaning that taxes are paid when money is withdrawn, not when it is put in. This is generally to the advantage of the employee, as most retirees have lower tax rates than when they were working as a result of substantially lower overall income.

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.

Taking Care of the Money

Management of the funds is usually handled in one of two ways. The most common management method is “participant-directed”, where the employee can select from several different investment options, usually including a variety of stocks, bonds, money market investments, and the company’s own stock. The less common method is “trustee-directed”, where the employer appoints someone to decide who the plan will be managed.

Withdrawing the Funds

One of the big problems with 401(k) plans is the restriction on what can be done with the funds before the employee retires. Usually there are very stringent requirements that must be met before an employee would be allowed to withdraw the funds early. And, the federal government imposes a 10% tax penalty on top of the normal income tax that would be due if the employee takes the money early.

One option to get access to some of the money from a 401(k) plan early is to take out a loan from the plan. Some plans allow low interest loans from the plan under certain circumstances. Nevertheless is best if employees only contribute as much to the 401(k) as they can afford.

Transfers

With todays 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.

Last 5 posts by Daniel Beckett

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Tags: Investing