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A 401K plan is a retirement plan established by employers which
lets employees save a portion of their earnings, before taxes
are taken out.
A 401K is funded with worker’s pre-tax dollars and employers
contributions (if any). Both the growth of the funds, and the
employers contributions are tax-deferred, which means you only
pay taxes when the money is withdrawn. In that sense, 401Ks are
similar to Individual Retirement Accounts (IRA), where the money
cannot be withdrawn until the age of 59 and a half, except for
special circumstances. However, most employers include
an option of obtaining loans against 401K accounts.
Nowadays, a 401K is offered in place of a traditional pension.
It can be a very powerful tool to make up the difference between
your Social Security payment and the pre-retirement earnings.
401K contribution limits.
The plan allows each enrolled employee to contribute a certain
amount of their salary up to the limits established by employers
at the time the plan was set up. The details of those limits vary
among employers.
The Internal Revenue Service (IRS), on the other hand, has its
own limits. In 2005, it is $14,000 and in 2006, it will be $15,000.
The IRS also allows catch up contributions to the 401K plan
for persons who are 50 or older. The catch up contribution
limits are as follows: 2005, $4,000 and 2006, $5,000.
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401K main benefits.
- account balance grows quickly, because not only are the employer’s
and employee’s contributions tax free, but the growth of
the funds are also tax free.
- your contributions are tax free, which might put you in a lower
tax bracket, essentially saving money on federal, and in most
cases, state taxes.
- portability: when leaving an employer you can take the money
with you and put it into the new employer plan or, roll it over
to your Individual Retirement Account.
- you are in control of your money. It is up to you how and where
the money is invested.
- A 401K is usually set up as payroll deductions which make saving
easy.
- you are able to invest in large managed funds that have high
minimum investment
requirements.
- most 401k plans have a loan option: you borrow
from your own account with no penalties (or taxes), and pay it
back to yourself, including the loan
interest.
See also: 401k
contribution, 401k
investing, Roth
IRA, interest
rate
Related topics: 401K
calculator, 401K
fees
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