401K plan has a defined basic structure with some flexibility in how the organization can choose to administer the same for the benefit of its employees. Some of the features are listed below and they will help you understand the basic structure of a 401K plan:
Basic Structure of a 401K Retirement Plan:
- The employees are given an opportunity to invest a salary percentage up to a maximum limit as defined by the law.
- Some of the employers match a part of your contribution to the plan to a certain defined predetermined amount. For instance, an employer may contribute up to 3 percent of your salary if your contribution to the 401K plan reaches a certain minimum amount.
- Generally, your employer can enroll you into the 401K plan after you complete working for certain period (6 months to 1 year). However, in some cases, employees are enrolled into the plan on the day you join the organization. Employees do have the flexibility to opt out of the plan in case they do not want to choose automatic enrollment.
- The sponsors of the plan can determine the vesting period which refers to the timeframe that is set by the employer to gain access to the matching funds contributed by the organization to the 401K plan account. Vesting could be gradual (e.g. 20 percent per year) or complete (e.g. 100 percent after 3 years).
- Contributions made by the employee are 100 percent vested.
- Your personal contributions and your employer contributions are tax-deferred. After you cross 59.5 years, you pay ordinary income taxes on withdrawing. In case you choose to withdraw funds earlier, you may be subjected to a penalty of 10 percent.
- You pay lesser income taxes as your contribution to the plan is deducted from your wages while calculating the income tax.
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