401(k) Plans
A
401(k) plan permits employees to choose to defer
a portion of their wages on a pre-tax basis.
The 401(k) plan must be part of a qualified
profit-sharing plan, a stock bonus plan, a pre-ERISA
money purchase pension plan, or a rural cooperative
plan. A 401(k) plan frequently features an "employer
matching" provision in which the employer
makes a contribution to the plan equal to (a
certain percentage of) the employee's contribution.
This serves to encourage participation among
employees at all levels.
The
company usually offers at least four alternative
investment vehicles. Because the law requires
that participation in the plans not be too heavily
skewed towards more highly paid people, companies
generally offer a partial match to encourage
broad participation in these voluntary plans.
This match can be in any investment vehicle
the company chooses, including company stock.
There is a combined limit of 15% of taxable
pay that the company and the employee together
can contribute to the plan. For example, if
an employee is making $30,000 per year and contributed
$2,000 to the 401(k), the combination of the
employee's $2,000 contribution and the company's
match cannot exceed 15% of $28,000 ($4,200).
This 15% limit is further reduced by contributions
to other tax-qualified retirement-oriented benefit
plans.
The
major benefit to employees of the 401(k) plan
is that they are not taxed currently on the
portion of compensation that is placed in the
plan. An employee has the option of choosing
between cash or future benefits on a year-to-year
basis. In addition to the tax deferral, another
major benefit is that a 401(k) plan is eligible
for five-year averaging on distributions. But,
if an early distribution is taken, the amount
is subject to an additional 10 per cent tax.
Because
a 401(k) plan is a qualified plan, it is subject
to the same rules imposed by the Internal Revenue
Code and ERISA as are all other qualified plans.
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