What Is The Basic Structure Of A 401k Plan ?
The US Congress amended the Internal Revenue Code in the year 1978 to include Section 401, which was to be a boon for the employed masses of the nation. This new plan assured employees that they would not be taxed on a certain amount of their income if they chose to invest that amount in an account accessible to them only at a much later stage.
The plan states that every employee has the option of having a certain amount of their salary deducted at source, which is transferred into an account which is for their erstwhile retirement. This amount is not taxable at that time. The choice is either a small percentage of the income or a particular amount of dollars, which is directly transferred into that account. For example, if one’s income is $20,000 and wishes to set aside $5,000 into the 401k plan, then the person will only be taxed on $15,000. The 401k plan account is stated to be accessible only after the person turns 59 and half years of age. Any withdrawals made before that means a penalty and tax deductions. Withdrawal after this age means tax on anything that you wish to withdraw. Thus, it is not advisable to withdraw money from that account till retirement.
Employers often advise their employees to invest the amount in mutual funds and bonds and stocks. While some companies let you join the plan after a certain amount of time serving in the company, others make it mandatory from the very first day. However, the decision to opt out of such an automatic process lies with the employee. The other disadvantage is that one can only invest that amount in the funds or investments that the company has at its disposal. But, there is an upside to this plan as well. Sometimes the employers try and match the investment the employee has made which makes it beneficial for both parties in the long run. And from a more logical point of view, it saves time and effort to create an additional account for the future because the company does it for the employee.
Changing jobs does not have an adverse effect on the Plan. The account can remain with the former employer’s company or can be shifted to the new employer’s company. One can also choose to close that account and start a new one at the new company but that would mean unnecessary taxes and penalties. Earlier, companies could shut down the accounts of former employees, causing much distress to the employee but after March 2005, companies now cannot shut down that account if it has more than $1000 in the account. This is another added advantage that the government took to protect the interests of the working professionals of the nation.
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