Understanding The 401(k) Plan

The 401(k) is just one type of many retirement plans that is sponsored by one’s employer. It is a type of retirement plan that allows an employee to save a portion of earnings for retirement while putting taxes on it on hold for awhile up until the fund has been withdrawn.

As an employee benefit, a 401(k) must be sponsored by an employer, usually that of a private corporation, although a self-employed individual may be able to do so as well. As an employee benefit, it is up to the employer to design and set-up a 401(k) plan for his employees.

A 401(k) plan is a type of profit sharing plan that has its own cash and deferment arrangement. It can differ from your typical pension plan in that the contributions are voluntary and that the benefits or contributions are not defined. 401(k) plans are also considered as tax-qualified plans and its assets generally protected from the creditors.

In case of employer bankruptcy, the assets included in the 401(k) are safely protected unlike other types of pension plans. But in the same manner, the value of the employee 401(k) may be affected if it has been invested in employer stock if in case that employer goes out of business.

Another advantage of a 401(k) plan is that some companies may be able to match employee contributions to some extent. This acts as an incentive for the employee to be motivated to save more for retirement. This may depend upon the employer and may usually be in force as long as the employee stays with the same company, therefore may also persuade employees to stay with the employer.

When an employee leaves a job, his or her 401(k) plan may continue to be active and can become one for the rest of the plan holder’s life. Some companies may also charge a fee in order to maintain the 401(k) of a former employee. But it will also depend on the employee’s next company.

If an individual transfers to a new company that hosts its own 401(k) account, that individual may be able to roll over his or her previous 401(k) plan to the one hosted by the new employer. In the absence of a new 401(k) account in the new company, the employee may also have the option to have his or her previous 401(k) plan into an IRA plan at an independent financial institution. These options are for the 401(k) plan holder to decide upon.

401(k) plans may offer certain advantages to employees. One of the advantages is that the employee may be able to decide how much is to be invested in the 401(k) plan. Other traditional pension plans may not have this option and instead provide only a specified amount that would be taken from the plan holder’s paycheck.

Another benefit offered by 401(k) plans is that income from the plan is not taxable while it remains untouched. The tax may only be charged upon the income once they are withdrawn from the plan. This allows the investment in the 401(k) to grow better with more money that would have otherwise gone to taxes.

401(k) plans also offer additional options to holders where they invest their money. Instead of contributing to a mutual fund or simply investing in the company’s stock. 401(k) plans allow plan holders to have the option of investing in a wide selection of stocks, bonds and other investments.

 

Posted by Ardent Editor on Sep 19 2007 in 401k & Company Plans

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