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What is an Individual 401k?

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  • Written By: B. Schreiber
  • Edited By: A. Joseph
  • Last Modified Date: 12 August 2019
  • Copyright Protected:
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    Conjecture Corporation
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An individual 401k is a type of retirement savings plan in the United States for someone who owns a business. Such a business can have only the owner as an employee, with the exception of spouses. An individual 401k is similar to other employer-sponsored retirement accounts. Like other retirement plans, the person owning the account can make contributions throughout his or her career to ensure a more financially comfortable retirement. For individuals who are sole proprietors of their businesses, it can be an important part of retirement planning.

The individual 401k is a defined-contribution plan, in that it allows a person to set aside, or defer, a limited amount of salary or compensation. The amount or percent of income that can be contributed is limited and subject to annual revision. The individual 401k contributions usually are invested in stocks or mutual funds. Many Americans are offered 401k plans through their employers, so those in individual 401k plans might need to do more work to select one for themselves.

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As with other retirement accounts, an individual 401k can be a traditional tax-deferred account or a Roth account. In the former, a limited amount of pre-tax compensation is contributed to the account and will instead be taxed at the time of withdrawal, possibly at a higher rate. The Roth account allows after-tax contributions and are not taxed at the time of withdrawal. A person with an individual 401k can own both types of accounts simultaneously and can contribute to both, but he or she can't contribute more than the annual limit for a single account.

The traditional form of an individual 401k generally is subject to penalties for withdrawing money before the age of 59-and-a-half, except in cases of death or personal disability. Also excepted are higher education costs, medical insurance premiums during a time of unemployment or financing for first-time home buyers. An owners of a Roth 401k may withdraw contributions before the age of 59-and-a-half, but the rules on withdrawing interest differ. For traditional accounts, minimum distributions from the account become mandatory at the age of 70-and-a-half. A Roth 401k does not have a point at which distributions become mandatory.

An important question for anyone planning for retirement is determining the amount of money that will be needed. It is then important to find what the necessary contribution from each paycheck or year will be. To choose an individual 401k, one should enlist the aid of a personal bank, broker or investment adviser. The online services of a large no-load mutual fund house or broker also can be used.

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