SavingsTalk.com

titan22

What is a 401(k)?

A 401(k) plan is a qualified profit sharing (meaning before tax dollars) or stock bonus plan that contains a cash or deferred arrangement or (CODA). Under CODA, and eligible employee can elect to defer some of his or her pay by instructing the employer to contribute to the qualified plan. This is the "deferred" portion of the arrangement. A 401(k) plan may be a stand-alone plan permitting elective contributions only or may also permit employer match and/or discretionary contributions.

The amount contributed to the plan under the CODA on behalf of the employee is called an elective contribution. Subject to certain limitations, elective contributeions are excluded from the employee's gross income for the year in which they are made and are nut subject to taxation until distributed. Of course, the employee may also decide not to defer any pay. This is the "cash" portion of the arrangement.

Contributions:
Depending on specific plan provisions, there are several types of contributions which may be made under a 401(k) profit sharing plan. At a minimum, 401(k) plans generally allow for employee deferrals. In addition to employee deferrals, the employer may also allow an employer to make discretionary profit sharing contributions. The legal limit for annual contributions an employee may make is $15,000.

For example:
Often employers will match up to a certain percentage of the employees income. If the employer will match, for example 3% of the income, the employee can contribute 3% of his/her paycheck and get 3% matched by the employer. If the employee makes $50,000 per year, they can contribute up to $15,000 (legal limits), but the company will match 3% of the salary (not the contribution). So, the best interest of the employee would be to contribute $1,500 and let the employer contribute the matching amount of $1,500. So they would get another $1,500 essentially added to their annual salary. And all of this is grown tax deferred until withdrawal.

Distributions and withdrawals:
Once contributed to the plan, employee 401(k) deferrals generally may not be withdrawn from the plan without the occurrence of certain triggering events, which would allow for a distribution or in-service withdrawal, as provided in the plan provisions.

Triggering events include, severance of employment, death, disability, attainment of normal retirement age, and plan terminiation.

Tax Consequences:
In general, any distribution from a 401(k) is included in the income of the recipient for tax purposes and, therefore, is taxed. However, if an employee has made a nondeductible employee contributions to a plan, a portion of each distribution representing the return of those after-tax contributions will not be taxed.

A distribution (including a distribtuion upon plan termination) to an elmployee before he/she reaches age 59.5 is generally subject to a 10% penalty on that portion of the distribution of which is included as income. This penalty is applied to all distributions, not just the growth and dividends. This is a common confusion of retirement plans.

Required minimum distributions:
There required minimum distribution amount is the account balance, divided by the life expectancy of the participant.
*the account balance is generally the market value at December 31 of the year preceding the year age 70.5 is attained
*The life expectancy is generally the factor from the Uniform Life Time Table. An exception applies if the only primary beneficiary is the participant's spouse who is more than 10 years younger and the Joint Life Expectancy Table may be used.