A 401(k) is a type of retirement savings plan that is designed to allow employees to save a portion of their income prior to paying taxes on it. This results in an immediate tax benefit to the employee, and often to his company as well, since any matching funds the employer contributes are considered a business write-off. Since the funds are intended to provide a source of income once the account owner reaches retirement age, he is generally discouraged from withdrawing any of the money early.
Most 401(k) plans are funded through a combination of employee and employer contributions. Money that is placed in a qualified retirement savings plan, such as a 401(k), is not counted as income for that year, which is what creates the tax savings for the account owner. While it is in the plan the money is invested in various ways, which usually results in earnings for the account owner. When the funds are distributed once the account owner has retired, the money is taxed as ordinary income at the participant’s tax rate at the time it is received.
Summary Plan Description
The summary plan description (SPD) is an important document for anyone involved in a 401(k) plan. The SPD spells out exactly what can and can’t be done in the plan. In many cases an employer is not required by law to allow certain types of distributions or contributions, and the SPD covers how the plan handles various situations. This document also provides information on employer matching funds and the loan policy, as well as identifying the name of the trustee managing the fund and any other people or companies that are involved.
The conditions under which someone may withdraw her funds from a 401(k) are covered in the SPD. Despite the fact that the employee owns any vested funds in the account, if the plan does not allow for the withdrawal of funds under different circumstances, such as for various hardship situations, the trustee is within his rights to refuse to allow a participant to take funds from her account. Anyone signing up for a retirement plan should carefully read the plan documents before signing, to make sure she knows what the restrictions on accessing her money are.
If the employee is no longer with the company, he has the right to remove his money from that company’s 401(k) plan. In such an instance the trustee cannot refuse to release the funds. When distributing such funds, the trustee is required to withhold 20 percent of the amount for taxes unless the money is released directly to another qualified retirement plan. If the employee does not qualify to receive the funds without penalty by virtue of age or circumstances, the trustee must also withhold an additional 10 percent. The rest of the vested funds can be given to the account owner, who must then treat them as income for that year. To avoid these fees, you can rollover the 401(k) funds into a qualified IRA.
- Making a financial plan image by Allen Stoner from Fotolia.com