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401(k) Plan Basics

We are interested in learning more about the basics of a 401(k) and how it can be used by our employees. Can you give us a general overview of what a 401(k) is?

Sure. A 401(k) is a very common form of an employer-sponsored retirement plan, which is similar to an IRA. Many businesses across the country offer 401(k) plans to their employees and many companies offer a matching program that is based on a percentage of the employee contribution to the savings plan (ie: an employer may match four percent of the amount of money that the employee contributes).

Basically, a 401(k) is a savings plan that allows employees to save money each year for their retirements. Employees defer paying income taxes when they stow money away in their 401(k) accounts. This money is tax-deferred, which means that when the employee eventually goes to withdraw the money, he or she will have to pay taxes on it then.

When an employee has a 401(k) account, he or she will have a portion of his or her wage set aside to be put directly into the account. There are two types of accounts that your business may use:


In a participant-directed plan, which is the most common option for a 401(k), your employees will able to select the investment options that they prefer. For example, your employees can choose between mutual funds, money market accounts, stocks, bonds, and more than one type of investment. You may also be able to offer your employees the option of investing in stock for the company.

Trustee-directed plan

In a trustee-directed plan, it is up to employer to appoint a trustee who will then make decisions about where an employee invests his or her money. This type of plan is considerable less popular.

Note: in recent years, there has been an update to the 401(k) plan laws. Before 2006, all Roth 401(k) contributions were made on a pre-tax basis, which means that no income tax was withheld and the contributions or growth associated with the plans were not taxed until money was withdrawn. Now, however, all 401(k) assets are tax deferred.  As such, when an employee makes distribution from a Roth account, the distribution is tax free, but contributions to the accounts are made on an after-tax basis. CB

This entry was posted on Sunday, September 23rd, 2007 at 11:46 pm and is filed under
Benefits, Compensation, Human Resources Management, Labor Laws.
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