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What is the plan? 401 (k) is the plan

  • Published
  • By Nick Mitchell
  • Fort Dix judge advocate
FORT DIX, N.J. --  Most people have heard of a 401(k) plan, but what exactly is a 401(k) plan? The 401(k) plan gets its name from a section of the federal tax code. It is an employer- established plan similar to an Individual Retirement Account in that both plans are designed as retirement savings accounts. A 401(k) plan (hereinafter "401(k)) is funded with your before-tax salary contributions and, many times, matching contributions from your employer (which is an instant benefit to your retirement fund). Once you have money in your 401(k), you normally cannot make withdrawals before age 59 ½, except for special circumstances. However, many employers do provide loan provisions in their plans.

Any contributions to and growth of your 401(k) are tax deferred, which means your money is not taxed until withdrawn. Your gross income is reduced by the amount you contribute, which means your contributions are not subject to federal or most state income tax. Contributions are still subject to Medicare and Social Security taxes. You get taxed when your money is withdrawn, usually when you retire. Additionally, when you retire, you may be in a lower tax bracket and pay less tax on your withdrawals.

Many 401(k) accounts allow borrowing, which lets you make a loan to yourself, without penalties or taxes. When you pay the loan back, any loan interest also goes back into your 401(k). You can usually pay back the loan (and contribute to your 401(k)) by automatic payroll deduction.

Unlike traditional pension plans, you can control your 401(k). You can choose how to invest your contributions and be as aggressive or conservative as you desire when selecting investment options offered. Normally, you can invest in professionally- managed funds with no minimum investment requirements.

Lastly, your 401(k) is portable. If you leave your current employer, your 401(k) funds can be rolled over into your new employer's 401(k) or into an IRA. The IRS Web site, www.irs.gov/faqs/faq-kw7.html, answers frequently asked questions about 401(k) pension plans and includes links to other IRS sites related to retirement.