The 401(k) takes its name from subsection 401(k) of the Internal Revenue Code. It cropped up in the 1980s as an appendage to pensions. A 401(k) is a retirement savings plan and is sponsored by an employer.
The workers can save and invest a part of their paycheck before giving the taxes. Taxes need not be paid before the withdrawal of the money from the account. This means that, you can save money towards your retirement without paying income taxes on your savings or on your investment earnings before you withdraw the money at the time of retirement. Even you can control how your money you are going to invest.
It has a number of limitations and admonitions. Generally, you can’t tap into your employer’s inputs immediately. There are stiff rules when you can withdraw the money and there are penalties for the withdrawal of the money before the retirement age.
Now you must be thinking how this plan is working. Before the taxes are withdrawn the money is deducted from your paycheck; hence your taxable income is lowered and consequently this lowers your taxesfor some services like the administrative, investment management, and sometime outside consulting services this plan charge fees which can be charged either to the employer, or the participants of the plan or to the plan itself.
401(k) plan comes in two varieties. The differences between them are the tax implications and the schedule for accessing your funds. Between these 2 types less common is a Roth 401(k).Some employers apply a waiting period before you can begin participating in their 401(k). This can be anything from one month to one year while the rest allow employees make contributions immediately.
You can be enrolled in 401(k) plan by most of the companies right away. However you might have to wait in some cases. In such cases you can start your own individual retirement account and then lodge a complaint with the HR office. If your company is unstable or it goes under then the plan is likely to be terminated. In such cases you can transfer the money to a traditional IRA to avoid paying the income taxes and 10% withdrawal penalty. Under the ‘force out’ provisionformer employees can close their 401(k) accounts if their account balances are low.
If you leave your employer, then you can do the following with your 401(k) account balance:
- Roll over the balance in your account into your new employer’s plan.
- Roll over the balance into an IRA.
- You may leave your balance in its plan, ifallowed by your former employer
- Withdraw your account
Employees can contribute the funds on a post-tax elective deferral basis, with addition to, pre-tax elective deferrals under their traditional 401(k) plan. An employee cannot exceed the IRS limits for deferral of the traditional 401(k). Matching funds of the employer are not included in the elective deferral cap, though they are considered for the maximum section 415 limit of $51,000 for 2013.