What is a 401(k) Plan?
A 401(k) plan is a tax-qualified plan under which employees can elect to have a portion of their pay contributed to the plan on a pre-tax or after-tax Roth basis. These plans are intended to help employees meet long-term objectives, such as generating retirement income. You can review this article for answers to some frequently asked questions about deferred comp plans.
How do 401(k) plans work?
Your contributions are invested based upon your election of the Savings Plus options.
As a 401(k) participant, you contribute salary deductions - or "deferrals" - which are placed in a participant-directed account. Contributions are limited to an annual maximum dollar amount, as established under the Internal Revenue Code (IRC). Investing involves market risk, including possible loss of principal. As you get started in the plan, we will help you understand market risk and strategies that may help you deal with market risk.
Why should you consider participating in a pre-tax 401(k) plan
Some advantages of participating in a pre-tax 401(k) plan are:
- Your contributions and any earnings are tax-deferred
- Your money has the potential to grow with the power of time and compounding
- You may be eligible to take a tax credit (Saver’s Credit) for contributions to your account
- You can begin taking withdrawals at age 59½, regardless of your employment status
- You may be able to take a hardship withdrawal, if your situation meets certain qualifications
- You may be eligible for a loan
Can a 401(k) plan include designated Roth accounts?
Savings Plus allows you to designate your deferrals as Roth contributions. Distributions from the Roth account may be tax-free if certain criteria are met. Understand the differences between pre-tax and Roth contributions.
Can I participate in both a 401(k) and a 457(b) plan ?
You may enroll in both, however administrative fees will apply in both plans. You should evaluate which plan(s) are right for you.
401(k) Plans and 457(b) Plans have some aspects in common. For instance, both plans allow for pre-tax contributions, after-tax Roth contributions, and rollover contributions from prior employer plans. Both plans limit withdrawals to qualifying circumstances. Both plans allow for age-based deferrals (age 50 or older).
What are the differences between 457(b) and 401(k) plans?
Some key differences between the 457(b) and 401(k) plan are as follows:
- If you plan to separate from service or retire before age 55 and begin withdrawals before age 59½, an additional 10% early withdrawal tax may apply to the 401(k). In addition, any amounts which are withdrawn that have been rolled over to the 457(b) plan from a qualified plan or IRA may also be subject to an additional 10% early withdrawal tax.
- Another difference is that you may qualify for an in-service withdrawal from your 401(k) account due to a financial hardship. Some examples may include, but are not limited to, costs associated with the purchase of your primary residence or payment for tuition for post secondary education. You may qualify for an unforeseeable emergency withdrawal from the 457(b) plan if certain criteria are met. Contact us for more information.
- The 457(b) plan contains a traditional catch up contribution which may allow you to contribute a higher amount to make up for the years you were eligible to contribute to the 457(b) plan, but did not maximize your contribution for those years. The 401(k) plan does not contain this provision.
Get the help you need
Talk with a Savings Plus Retirement Specialist if you have questions about 401(k) plans or plan participation. Information provided by Retirement Specialists is for educational purposes only and is not intended as tax, investment or legal advice.
Source: “401(k) Resource Guide - Plan Participants - 401(k) Plan Overview”, Internal Revenue Service, www.irs.gov (accessed Jan. 10, 2012)