401(k) plans are tax-deferred retirement savings plans for employees, offered through an employer. It is a type of savings plan designed to supplement a person's social security benefits when they retire. A 401(k) retirement savings plan allows a worker to save for retirement and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal. The employer sets them up and each company has a slightly different 401(k).The plan is funded by employee contributions and (often) matching contributions from the employer. The major attraction of these plans is that the contributions are taken from pre-tax salary, and the funds grow tax-free until withdrawn.
How Does a 401(k) Work?
When a 401(k) plan is offered to an employee under the Employee Matching Program, the employer usually matches a portion of the money, sometimes as high as 50 percent, that goes into the 401(k) account. In a way this is extra pay the employee gets. The amount that is withheld from the employee's check is up to the individual. It can be anything from one percent up to whatever the company allows. This money gets invested into stocks or bonds that the employee chooses from. Most companies have several option ranging from high-risk, high-yield stocks to very minimal risk bonds. The percent of the 401(k) money that is invested in the various stocks and bonds depends on the employee's choices, and how much risk they are willing to take to get a return on their money. The employee should be knowledgeable about what they are investing in, and keep a watchful eye on the plan and the money that is in it. Read these tips for more details.
The money is deducted from the employee's wages tax-free, and no tax is due until the money is accessed at retirement, or withdrawn early. Some companies do allow the employee to "borrow" money from their plan. The employee can only access 50 percent of what is in the 401(k) plan, and this is paid back weekly, by deducting it from the payroll check. The benefit of this is that the employee is paying back the interest money to their own account instead of paying it to a bank.
Who is Qualified For a 401(k) Plan?
In general, an employee must be allowed to participate in a 401(k) plan after meeting the following requirements:
He or she has reached age 21.
He or she has at least one year of service - A traditional 401(k) plan may require 2 years of service for eligibility to receive an employer contribution.
Types of 401(k)
Traditional 401(k) Plan: This type of plan offers the maximum flexibility in any type of 401(k) plan. Employers have the discretion to make contributions on behalf of all participants, to match employees' deferrals, or to do both. These contributions can be subject to a vesting schedule (this provides that an employee's right to employer contributions becomes theirs only after a period of time). In addition, one of the biggest benefits to employees is that through a traditional 401(k), participants make pre-tax contributions through payroll deductions.
Safe Harbor 401(k) Plan: This plan is similar to a traditional 401(k) plan, but, among other things, must provide for employer contributions that are fully vested when made. However, it is important to understand that the Safe Harbor 401(k) is not subject to many of the complex tax rules that are associated with a traditional 401(k) plan, including annual nondiscrimination testing.
SIMPLE 401(k) Plan: A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that will apply to the traditional plans. Similar to other 401(k) plans, the employer is required to make employer contributions that are fully vested. This type of 401(k) plan is only available to employers with 100 or fewer employees who received at least $5000 in compensation from the employer for the preceding calendar year. In addition, employees that are covered by a SIMPLE 401(k) plan can not receive any contributions or benefit accruals under any other plans of the employer.
Roth 401(k): Under the Roth 401(k), employees can decide to contribute funds on a post-tax elective deferral basis, in addition to, or instead of, pre-tax elective deferrals under their traditional 401(k) plans. The difference between a Roth 401(k) and a traditional 401(k) is that the Roth version is funded with after-tax dollars while the traditional 401(k) is funded with pre-tax dollars. After-tax dollars represent money for which taxes are paid in the current year, and pre tax dollars are those that do not represent federal taxable income in the current year. Typically, the earnings on Roth contributions will be tax free as long as the distribution is made at least 5 years after the first Roth contribution and the attainment of age 59 1/2, unless an exception applies.
The best retirement tool is highly individualized and depends greatly on how old you are, how much you contribute and the amount of years you have until retirement. A calculator will help you figure out the savings with each kind of retirement plan based on the annual contribution, your current tax rate, the expected rate of return and the tax rate when you retire. Although future tax rates are difficult to predict, you may benefit from a Roth 401(k) if you anticipate being in a higher tax bracket during retirement.
401(k) plans are tax-deferred retirement savings plans for employees, offered through an employer. It is a type of savings plan designed to supplement a person's social security benefits when they retire. A 401(k) retirement savings plan allows a worker to save for retirement and have the savings invested while deferring current income taxes on the saved money and earnings until withdrawal. The employer sets them up and each company has a slightly different 401(k).The plan is funded by employee contributions and (often) matching contributions from the employer. The major attraction of these plans is that the contributions are taken from pre-tax salary, and the funds grow tax-free until withdrawn. 
