Salary Reduction Plan 401(K)

by Manshu on November 20, 2006

in Articles

This is a qualified plan provided by the employer to eligible employees of their organisations. The contributions to this plan are made by the employee on a salary deferral or salary reduction basis. It means that the employee’s pre-tax salary, matching his contribution to the Plan, is deducted and paid into his 401(K) account directly by the employer. The employer too sometimes makes a matching contribution into the employees 401(K) account. Sometimes the employer adds a profit sharing feature to the 401(K) plans as there is a provision in the plan which enables him to do so if it is in the interest of the employees.  However it must be understood that all the earnings in this account are tax-deferred, meaning tax has to be paid at the time of withdrawal. There are, of course, limitations placed by the IRS on the contributions to the plan.

The salary reductions which are available to you will depend on your place of work. Many organisations whether privately or publicly held, offer the 401(K) salary reduction plans. However, some non-profit organizations like schools, colleges, museums and hospitals can also offer this plan, though many prefer the 403 (b) plans. The 401(k) plans first introduced in 1981 became so popular that by 2004 they had about 43 million participants. These numbers have steadily been increasing over the years because this plan offers you a choice to take your full salary home or contribute to a qualified plan and not only save for the future but also to save tax not only on your contribution but also on it earnings.  The amount of tax that is to be paid can only be known at the time of withdrawal of the monies from the account. However your income being less after retirement there is bound to be a tax benefit at the time.
 You can opt for this plan provided you are eligible and to be eligible you have to be employed for 365 days starting with the first day on the job.  You can also be eligible if you have put in 1000 working hours during the year. It is also a good to know what you are getting into when you enrol and become a part of the plan. Like your contribution, your employers matching contribution, the decisions you may have to take to direct the growth of your investments and other benefits that make your retired life better.

However, being a part of plan 401(K) provides a good start to your retirement plans. Therefore it is better to start contributing earlier as an early start provides you with a greater chance to save a substantial amount in your retirement account.   This plan works for you even if you are self employed and have not yet incorporated your business. The only difference is that you can add only 20% of your compensation over and above your salary deduction. One of the benefits of this plan is that you can transfer your account to the similar one with your new employer in case you plan to join another organisation.
 

If you are taking a savings retirement plan, then Plan 401(K) definitely deserves a serious consideration.

 

 

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