401(k) plans are retirement plans setup by employers in the United States to take advantage of income tax deferment that is available. The money is put directly into the plan from wages earned by the employee. The plan is tax deferred, not tax exempt. That is, income tax must be paid on the whole amount when the employee retires and begins drawing on the plan.
One of the largest advantages of a 401(k) is that many employers will match funds deposited up to a certain amount. Usually, the amount an employer will contribute are either half or the full amount that they employee defers, up to a certain percentage of the employee’s full wage.
There are a couple of ways that the funds in a 401(k) plans are usually managed. The first, and most popular, is the employee directed. Here the employee is given a list of potential investments and is allowed to allocate and transfer the funds between the investment options available. The second is where there is a manager or trustee of the plan who makes all the investment decisions.
Withdrawing the Funds
One of the big problems with 401(k) plans is the restriction on what can be done with the funds before the employee retires. Usually there are very stringent requirements that must be met before an employee would be allowed to withdraw the funds early. And, the federal government imposes a 10% tax penalty on top of the normal income tax that would be due if the employee takes the money early.
One option to get access to some of the money from a 401(k) plan early is to take out a loan from the plan. Some plans allow low interest loans from the plan under certain circumstances. Nevertheless is best if employees only contribute as much to the 401(k) as they can afford.
With todays workforce being so mobile, it is unusual for an employee to work for one employer for a whole career. 401(k) plans allow for moving to another job, though. The plan can be transferred to an individual retirement account or can be moved straight to the new employer’s plan if the new employer has a 401(k) plan.