A 401k is a company/employer sponsored
retirement plan that allows workers to take out a portion
of money from their daily paycheques, store it on a retirement
plan account and earn interest tax-deferred. Tax-deferred
means this saved income is not taxable until you withdraw
it at the age of 65 or more.
A 401k retirement plan must be sponsored
by an employer or an organization. The actual work of
administration and monitoring of accounts is usually outsourced
to independent banks, mutual fund companies, financial
service enterprises and more. As soon as an employee gets
a paycheck at the end of the month, he can transfer a
portion of it (there are annual limits) to his 401k account.
Types of investments available include mutual funds, stocks,
bonds, money market instruments (both short and long term).
- Fixed percentage of paycheck goes
directly into 401k account
- Employer makes profit-sharing contributions into the
401k plan
- Employer as an incentive, puts in extra money (on top
of the paycheck deduction) into the employee's retirement
account
If an employee quits working with
his company, the 401k retirement account still remains
active for the rest of his/her life.
Note: After 2004, some companies have started charging
fees to administer and maintain your 401k retirement account
if you have left their company.
If you leave your current employer
and have a 401k account, you can move this account to
a professional financial institution. After this, the
account changes from a 401k retirement account into an
IRA account. However, if an employee quits his former
employer and joins a new one, he can do what's called
a 401k rollover to his new company.
- In 2006, there is a limit of $15000
that an employee can put into his 401k account. This is
a before-tax amount. For example, say you earn $50,000
a year. You can therefore allocate $15000 from this 50,000
and put it into the 401k account. What's your taxable
income? $50,000 - $15000 = $35000
- Every year after you initially
contribute an amount, you are allowed $500 more per year.
This accounts for inflation.
- Employees who are over 50 years
old are allowed what's called "catch-up contributions."
On top of the original $15000, >50 years old employees
can allocate an additional $5000 per year into their 401k
accounts.
- This $5000 is also subject to an
increase of $500 per year (to account for inflation).
- If you contribute more than the
set limit ($15000), the excess amount must be withdrawn
by April of the following year. If you do not do so, you
will have to pay a certain penalty as well as taxes on
the excess amount.
