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What is a 401k Retirement Plan?

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  • Written By: Felicia Dye
  • Edited By: Heather Bailey
  • Last Modified Date: 05 October 2018
  • Copyright Protected:
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    Conjecture Corporation
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A 401k retirement plan is a savings strategy designed to set aside funds for the later years of life. These plans are funded by employees, though sometimes employers will also add funds. 401k retirement plans are subject to numerous regulations, such as those that address contribution limits and the early withdrawal of funds.

The funds that are collected as 401k savings are deducted from a person’s wages. When a person enrolls in a 401k retirement plan, she chooses which percentage of her income she would like to put into the account. The federal government does place a limit on the amount a person can contribute in a year. Employers have the authority to limit this amount even further if they see fit.

Deductions are made from a person’s income before taxes are withheld, which means that tax will be charged when the account holder withdraws the money. One of the biggest benefits of this type of arrangement is that many people will have a lower tax burden when they are retired. Furthermore, the profits earned from many investments are subject to tax, but with a 401k retirement plan a person’s money can grow tax-free. Making contributions to the account is also a benefit because only the remaining portion of a person’s salary is subject to income tax.

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Some employers add funds to their workers’ accounts. The amount added depends on each employer’s policy. Some account holders are fortunate enough to have their contributions matched 100 percent. This means the employer will contribute the exact same amount as the employee. Many companies, however, only contribute a percentage of what the account holder puts in.

The money in the 401k retirement plan grows because it is invested in stocks, bonds and other securities. The account holder is generally allowed to choose how she would like to have her money invested. While it is not likely that she will be able to choose the exact stocks or bonds, she can determine which portion of the money is invested in which options from a list she will be given.

Withdrawing the funds from a 401k retirement plan before a person reaches the age where she is eligible to do so is generally not advised. There are several reasons for this. Early withdrawals, in most cases, will result in the account holder paying a hefty penalty. In addition, she will have to pay tax on the funds. Together, these costs can result in a significant reduction.

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