401k Plans are employer-sponsored retirement plans, first established under section 401k of the 1978 Internal Revenue Code.
Members of a 401k plan are required to make regular contributions to the plan, which are deducted from their pre-tax salary payments. In many cases, these are matched by employer contributions to the Plan. The money is invested in various mutual funds, bonds, stocks or other types of investment.
A major advantage of 401k plans is that employees pay no tax on their invested funds, including employer contributions, while they remain in the account.
Tax is payable on the money when it is withdrawn, but the employee may well be in a lower tax bracket by then, particularly if they have already retired.
Another benefit of the 401k Plans is their transferability. If an employee switches jobs, their 401k plan funds can be moved to a different employer’s account, or put into an IRA (Individual Retirement Account).
Alternatively, they can withdraw the money, although if aged below 59½ they will incur a financial penalty - typically 10% - as well as having to pay tax on the withdrawn funds.
401k plans are also popular because they usually offer employees choices as to how their money is invested, within the range of investment options offered by their particular plan.
Although 401k account funds cannot generally be withdrawn without penalties until the employee is aged 59½ years old, many plans offer tax-free loan facilities.
Some plans even allow employees to borrow up to half of their total account balance, up to a maximum of $50,000.
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