A 401(k) is a type of profit sharing retirement plan. These plans allow you to contribute pre-tax dollars and then invest those dollars in the investment options provided by your employer for the purpose of saving for retirement.
The earnings on your investments are tax-deferred until retirement. Your employer may also make matching contributions to your account.
401(k) plan highlights:
- In 2016. the annual defined contribution limit from all sources (employer and employee) is $53,000.
- In 2016, each individual employee can defer up to $18,000 per year. For those over 50 years of age, an additional catch-up contribution of $6,000 is allowed. The contribution limit amount is adjusted annually for inflation.
- In 2016, the annual compensation limit is $265,000.
- Employees are immediately 100% vested with their own salary reduction tax deferred contributions.
- Contributions to a plan can come from voluntary employee salary reduction or from the employer, or both.
- Contributions are deducted from each payroll in the amount determined by the employee.
- Employee withdrawals before age 59-1/2 may be subject to 10% penalty.
- Investment choices vary from employer to employer.
- The plan can permit loans and hardship withdrawals, but is not required to do so.
- Participants can start or stop contributions during the course of the year, as determined by the employer.
- The company sets the eligibility requirements within certain guidelines. Employers can restrict individuals with less than 1 year service, union members, non US citizens, part-time workers, etc. from being eligible for the plan.
- Employers can establish a vesting schedule, within certain guidelines, for the contribution the company makes to the 401(k). Employees are immediately 100% vested with their own salary reduction tax deferred contributions. The percentage that your employer's contributions are vested determines how much of the contribution you are entitled to if you leave the company. For instance, if you are 40% vested and your employer has contributed $1000 to your plan, you would be entitled to $400 upon departure.