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How Does A 401k Work: Definition, 401k Plans, Contributions, Withdrawls, Distribution, Beneficiaries And Balances
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Published: December 28, 2006
Most employees look forward to retirement.
Advertisements commonly show a couple of 60-somethings basking in the sun on the bright beaches of Florida, sipping mimosas between intermittent golf games.
For most people, however, these widely advertised dreams of retiring in comfort cannot be realized without a 401K plan. 401K plans can help everyday employees save for the future, taking into account variables, such as inflation.
Though companies are increasingly discussing 401K plans, many people still do not know the definition of a 401K.
The most basic definition of a 401K plan describes it as an employee-sponsored qualified retirement savings plan. The United States Internal Revenue Service defines 401Ks under its profit sharing sector.
Oftentimes, 401K plans are grouped into two main categories: defined benefit and defined contribution. With a defined benefit plan, employees who meet certain eligibility criteria receive a defined monthly amount to retirees. In this type of plan, the employee makes undefined, voluntary contributions throughout their job duration. With defined contribution plans, on the other hand, the retiree receives a lump sum, which is not defined. This means the retirement outcome is not known in advance.
These retirement investment plans are popular because, no matter the type of 401K distribution, it is a tax deferral plan. This means income taxes are postponed until the savings are withdrawn.
401K plans are covered by the Employee Retirement Income Security Act of 1974, which protects plans from creditors of the account holders and employer bankruptcy. These benefits make 401K plans more desirable than pension plans, which do not protect employees as thoroughly.
Though some plans allow voluntary contributions, there are 401K contribution limits. In 2006, this limit was $15,000. However, each year this 401K contribution limit is indexed for inflation. For example, in 2007, it will be $15,500. If the employee contributes more than the pre-tax limit to his or her 401K balance, they are required to withdraw the excess balance by April 15 of the following year.
When an employee leaves his or her job, they begin the withdrawal process, which includes a variety of 401K withdrawal rules. 401K accounts generally remain active throughout the duration of the retiree's life. Some accounts, however, must be emptied by April 1 of the year the retiree turns 70.
Though an employee can keep his or her 401K account even after they have left the company, some companies have 401K withdrawal rules which charge ex-employees fees for enacting their account. However, if the ex-employee joins another company that offers 401K options, they often have the option to roll over their retirement plan.
Every retirement pension plan must name a beneficiary in the event of the plan holder's demise. For married plan holders, the 401K beneficiary automatically defaults to the spouse. If a plan holder wants to name someone else—like his or her children—as a 401K beneficiary, the spouse needs to sign a legal waiver.
Though retirement may loom distantly in the future, it is important to plan for retirement as early as possible. 401k plans allow employees to plan for their future and the future of their family.
Sources:
401(k). 2006. Wikipedia. 21 Dec. 2006.
401K Help Center. 21 Dec. 2006.
Beneficiary Basics. 21 Dec. 2006.
Retirement Planning. 2006. About. 21 Dec. 2006.
Advertisements commonly show a couple of 60-somethings basking in the sun on the bright beaches of Florida, sipping mimosas between intermittent golf games.
For most people, however, these widely advertised dreams of retiring in comfort cannot be realized without a 401K plan. 401K plans can help everyday employees save for the future, taking into account variables, such as inflation.
Though companies are increasingly discussing 401K plans, many people still do not know the definition of a 401K.
Related Articles
Oftentimes, 401K plans are grouped into two main categories: defined benefit and defined contribution. With a defined benefit plan, employees who meet certain eligibility criteria receive a defined monthly amount to retirees. In this type of plan, the employee makes undefined, voluntary contributions throughout their job duration. With defined contribution plans, on the other hand, the retiree receives a lump sum, which is not defined. This means the retirement outcome is not known in advance.
These retirement investment plans are popular because, no matter the type of 401K distribution, it is a tax deferral plan. This means income taxes are postponed until the savings are withdrawn.
401K plans are covered by the Employee Retirement Income Security Act of 1974, which protects plans from creditors of the account holders and employer bankruptcy. These benefits make 401K plans more desirable than pension plans, which do not protect employees as thoroughly.
Though some plans allow voluntary contributions, there are 401K contribution limits. In 2006, this limit was $15,000. However, each year this 401K contribution limit is indexed for inflation. For example, in 2007, it will be $15,500. If the employee contributes more than the pre-tax limit to his or her 401K balance, they are required to withdraw the excess balance by April 15 of the following year.
When an employee leaves his or her job, they begin the withdrawal process, which includes a variety of 401K withdrawal rules. 401K accounts generally remain active throughout the duration of the retiree's life. Some accounts, however, must be emptied by April 1 of the year the retiree turns 70.
Though an employee can keep his or her 401K account even after they have left the company, some companies have 401K withdrawal rules which charge ex-employees fees for enacting their account. However, if the ex-employee joins another company that offers 401K options, they often have the option to roll over their retirement plan.
Every retirement pension plan must name a beneficiary in the event of the plan holder's demise. For married plan holders, the 401K beneficiary automatically defaults to the spouse. If a plan holder wants to name someone else—like his or her children—as a 401K beneficiary, the spouse needs to sign a legal waiver.
Though retirement may loom distantly in the future, it is important to plan for retirement as early as possible. 401k plans allow employees to plan for their future and the future of their family.
Sources:
401(k). 2006. Wikipedia. 21 Dec. 2006.
401K Help Center. 21 Dec. 2006.
Beneficiary Basics. 21 Dec. 2006.
Retirement Planning. 2006. About. 21 Dec. 2006.
