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The 401(K) Plan is a self-directed, qualified retirement plan established by an employer to provide future retirement benefits for an employee. Employee contributions are made on a pre-tax basis. Employer contributions are usually tax deductible. Roth 401(k) contributions are made after-tax, but qualified withdrawals in retirement are free from federal income tax. Many employers are presently enrolling new hires automatically in 401(k) Plans, allowing them to opt out later if they elect to not participate. This is done in an effort to encourage more employees to participate by starting to save for their retirements at earlier ages.

If you choose to participate in a 401(k) Plan, you are allowed to invest a percentage of your salary into your 401(k) Plan every month. In 2007 the maximum allowable annual contribution is $15,500.

If you will reach age 50, or older, before the end of the tax year, you are allowed to contribute an additional $5,000. Contribution limits are indexed annually for inflation. Money in your account accumulates tax deferred until you begin taking distributions in your retirement.

“Vested” Originated By “Placing Money In Your Vest”

Employer contributions are often subject to vesting requirements. Vesting means when the money is yours or when you can take “hold” of the money. Employers can determine their own vesting schedules, making employees partially vested over time and fully vested after a specific number of years. When an employee is fully vested, the employee is entitled to all of the contributions made by the employer upon separating from the company.

In 401(k) Plans that offer loans, you my also be allowed to borrow money from your account, up to fifty percent of the account value, or $50,000.00, whichever is less, with a five-year re-payment period involved. If you leave your job the loan may have to be paid in full soon after departure from employment.

Funds in your 401(k) Plan are portable. If you leave your job or retire, you are allowed to move your funds or take a taxable distribution. If you leave a company before you are fully vested, you will be allowed to take only the funds that you contributed, plus any vested funds, as well as any earnings that may have accumulated on those contributions. Often the funds in your 401(k) Plan can be “rolled over” into your new employer’s retirement plan without any penalty to you. You have the option to “roll over” your 401(k) Plan funds into an IRA also.

By law you are required to “begin taking minimum distributions from your 401(k) Plan no later than April 1 of the year after you reach age 70 1⁄2 years of age.” The actual law also reads, “Distributions from regular 401(k) Plans are taxed as ordinary income and may be subject to a 10% federal income tax penalty if withdrawn before age 59 1⁄2, except in special circumstance such as disability or death.”

Your 401(k) Plan can be an effective vehicle for saving for your retirement if your employer offers matching fund contributions. If you are eligible to participate in a 401(k) Plan, you should take advantage of this opportunity, even if your contributions must be very small. Often the 401(k) Plan is considered to be a second or additional retirement funding effort.

 

 

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