What is a 401(k) Plan?

A 401(k) plan is a tax-qualified program under which employees can elect to have the employer contribute a portion of their pay to the plan on a pre-tax basis. These plans are intended to help employees meet long-term objectives, such as generating retirement income. Please note that not all public employers offer a 401(k) plan.

How do 401(k) plans work?

As a 401(k) plan participant, you contribute salary reductions – or “deferrals” – which are placed in a participant-directed account. Contributions are limited to an annual maximum dollar amount, as established under the Internal Revenue Code (IRC).

Once in your account, you decide where you want to allocate your contributions from investment options selected by your employer, the plan sponsor. Investing involves market risk, including possible loss of principal. As you get started in the plan, we’ll help you understand market risk and strategies that may help you deal with it.

Why should you consider participating in a 401(k) plan

Six advantages of participating in a 401(k) plan are:

  1. Your contributions and any earnings are tax-deferred
  2. Your money has the chance to potentially grow with the power of time and compounding
  3. You may be eligible to take a tax credit (Saver’s Credit) for contributions to your account
  4. You can begin taking withdrawals at age 59½, regardless of your employment status
  5. You may be able to take a hardship withdrawal, if your situation meets certain qualifications
  6. You may become eligible for a loan at competitive rates

You will pay ordinary income tax when and as you withdraw from your plan account.

Can a 401(k) plan include designated Roth accounts?

Yes, but not all 401(k) plans do. If your plan offers this option, your Retirement Specialist can explain how you can elect to make after-tax contributions to your account so you can take tax-free withdrawals.

Can I participate in both a 457(b) and a 401(k) plan?

In most cases, yes.

And you may be able to contribute up the maximum amount allowed by the IRC. There are certain conditions to meet, which can be explained by your Retirement Specialist, if your employer offers both types of plans.

Get the help you need

Talk with a Retirement Specialist if you have questions about 401(k) plans or plan participation. Information provided by Retirement Specialists is for educational purposes only and is not intended as tax or investment advice.

Source: “401(k) Resource Guide - Plan Participants - 401(k) Plan Overview”, Internal Revenue Service, www.irs.gov (accessed Jan. 10, 2012)

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