401(k) Investment Plan: What is it?

Written by: BetterFinancePath Staff

The 401(k) investment plan is a popular retirement plan offered to employees through their employers and offers various tax benefits.  Introduced in 1978, this plan allows an employer to set up a special savings account with an investment company, bank, or insurance company.  The employee then contributes a certain part of his or her salary to this account each month.  This contribution is not taxed at the time of deposit.  Tax has to be paid only when it’s withdrawn many years later.  The employer may also commit to contributing a certain amount each month to the employees’ 401(k) investment plan.  The employer’s contribution in some instances might match that of the employee.  However, this is the company’s prerogative.

Benefits of 401 (k) Plans

Besides the tax deferral, an individual’s 401(k) plan can easily be transferred from one employer to another when an employee switches jobs.  The possibility of matching payments by employers is yet another lucrative aspect of this retirement plan.  Many employers match contributions by employers and, hence, not participating in a 401(k) investment plan is considered equal to forfeiture of free money.  The employee also has some choice in directing the type of investments they want for their 401(k) savings.  Also, the flexibility afforded in terms of opting out of the plan at any time, changing the monthly contribution, and changing the investment options are additional benefits of a 401(k) investment plan.

401(k) Plans Eligibility and Coverage

An individual can participate in a a 401(k) investment plan only if the employer offers the plan.  The employer can also delay eligibility for a while, sometimes up to a year, and it may not be possible to begin contributing to a 401(k) immediately.  In the case of part time or temporary employees, completion of 100 work hours or a year’s waiting period, are the norm.  The employee has to be 21 years of age or older to qualify for participation in this plan.  If the individual has more than one employer, then the contribution limit cannot exceed income obtained from that particular employer.  Income from other employers can be saved in a different plan.

Contribution Limits for 2011 and 2012

The 401(k) can only be made during the calendar year.  The contribution limit for the year 2011 is $16,500.  Contribution limits for future years are indexed to inflation and increase in $500 increments.  For those employees age of 50 or older, there is a catch-up provision that allows them to contribute an additional $5,500 per year to their 401(k).  The employer contribution limit is 6 percent of the employee’s pre-tax compensation.  Employees with incomes above $110,000 in 2010 or 2011 may have some additional limits imposed on them by the employer.  You can start making withdrawals from your 401(K) account at  the age of 59 ½.   The IRS requires you start making mandatory withdrawals from your 401(k) once you reach the age of 70 ½ .  The minimum distribution of the mandatory withdrawal depends on your age, changes each year, and is specified by the Internal Revenue Service (IRS).


401(k) Investment Plan: What is it?

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