401k plans are set up by many employers to allow employees to save for retirement by setting aside some of their current income until they retire. 401k plans cannot be transferred, except on the death of the plan holder, and cannot be sold, although individual investments within the plan can be sold.
How a 401k Plan Works
401k plans are tax-advantaged, meaning that they give the plan holder a tax break when contributions are made to the plan. Because the benefit has already been conferred to the employee, a 401k plan, like other retirement plans, cannot be sold to anyone else. The plan must stay in the name of the plan holder and he will be taxed on withdrawals from the plan. If those withdrawals occur before the plan holder turns 59 1/2 years old, the IRS also levies a 10 percent penalty on the total amount of the withdrawals.
Selling Assets Within a 401k Plan
Plan holders are allowed to buy and sell individual investments within the plan as long as no funds or assets leave the plan. 401k plans differ in how much control the employee has over the investment mix and individual investments in the plan. Some plans are managed by the financial institution, while others allow the employee to choose from a group of allowable investments. The gains or losses on the sale of investments in a 401k plan are not taxable until withdrawn.
Death of the Plan Holder
What happens to funds left in a 401k plan when the employee dies can be complicated. If there is a surviving spouse, the funds can be rolled directly into her individual retirement account without any tax consequences. Withdrawal rules for the spouse then follow the basic withdrawal rules of the IRA. For non-spouse beneficiaries, the IRS allows for a direct transfer to the beneficiary's IRA; however, the plan is not required to be set up to do so. Each plan has its own rules as to the procedures that must be followed upon the death of the plan holder. If a non-spouse beneficiary does not have the option to roll the 401k into an IRA, the plan administrator will withdraw the remaining funds from the plan and issue them to the beneficiary. This can result in immediate tax consequences, but there will be no penalty levied even if the employee was less than 59 1/2 years old at the time of death.
Tax Implications of Withdrawals
Withdrawals from a 401k plan are taxed as regular income, without regard to whether it was part of the original contributions or was income that built up in the plan. If the withdrawals are made before the employee turns 59 1/2, there is also a 10 percent penalty assessed, unless an application for a hardship withdrawal is made.
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