What Is 401k Plan – An Overview

Named after the Internal Revenue Section 401k which explains the program, 401k is a form of retirement savings account offered in the United States. This program took effect in January 1, 1980, with the first plans officially adopted by Americans in January 1982. A 401k plan is a retirement plan established by employers where the employee can elect to make contributions to the account via salary deduction. This would mean that both the employer and the employee can put a certain amount of money together into the plan. 401k plan is a qualified plan, which means that the plan must meet the requirements specified by the IRS to become qualified for tax benefits and advantages. Funds in 401k plan can be put in a wide variety of investments, such as stocks, bonds, and Guaranteed Investment Certificates (GICs).


In 401k plan, contributions can be made before (pretax) and after (aftertax) payroll taxes. When an employee contributes in a pretax basis, the earnings he made upon investment grow tax-free. This means that the profits acquired on the account are not subject to taxes until you pull your money out upon reaching the age of 59 ½. Simply put, you will be taxed only upon withdrawal of your money during retirement. This is a good investment since the employee does not pay federal income tax on the amount of his present income.
This lessens the employee’s current taxable income and just put out the taxes until retirement, the time when he is more likely to be in the lower tax bracket.


There exist some 401k plans, however, like the Roth 401k plan, which allows employees to make contributions on an aftertax basis. In this type of plan, the person’s contributions are taxed during employment but the withdrawals made upon retirement are tax-free. There are, however, certain conditions that must definitely be met in order to qualify for such plan. For one, you need to hold your funds in the plan for a certain number of years before you are allowed to withdraw them. Any amount of money that is pulled out before the age of 59 ½ is subject to a 10 percent penalty tax, unless some exceptions apply.


The IRS puts limitations on how much a person can make and also sets some boundaries on how and when you can pull out your savings. The many benefits and advantages of 401k plans can truly help your retirement investments grow to a much faster rate. This is the reason why many investors consider 401k plans as their greatest retirement asset.

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