401(k) Plan
A 401(k) plan lets an employee defer a portion of compensation into a special type of profit sharing (or stock bonus) plan. - The employee's elective salary deferrals are not included in the employee's gross income. This means contributions are made with before-tax dollars.
- Earnings inside the plan accumulate on a tax-deferred basis.
- Employer contributions (if any) are deductible up to prescribed limits.
The annual limits on elective deferrals into a 401(k) plan, and the additional "catch-up" contributions permitted for participants age 50, are summarized in the following table: | Year | Deferral Limit Under Age 50 | Deferral Limit Age 50 and Over | | 2003 | $12,000 | $14,000 | | 2004 | $13,000 | $16,000 | | 2005 | $14,000 | $18,000 | | 2006 | $15,000 | $20,000 | | 2007 | $15,500 | $20,500 | | 2008 | $15,500 | $20,500 |
These limits apply to participation in all cash or deferred arrangements and may be reduced by elective deferrals to a 403(b) plan, 457 plan, SIMPLE IRA, or SIMPLE 401(k). Many employers match all or a portion of the amount deferred by each employee. Thus, the amount actually deposited on behalf of an employee can exceed the elective salary deferral limit. However, the annual additions to an employee's 401(k) account from all sources—elective deferrals, employer matching contributions, additional employer profit-sharing (discretionary) contributions, and forfeitures for any employee--cannot exceed the Section 415 limit for defined contribution plans. The Section 415 limit is the lesser of 100 percent of compensation or $45,000 (indexed after 2007). The employee elects the compensation amount he or she would like to contribute to the plan (subject to the limit). An employer contribution (if the employer provides matching funds) may also be made. The employee is not currently taxed on any salary deferred into a 401(k) plan. Thus, the employee invests for retirement with before-tax dollars.> The employer receives a tax deduction for any contributions it makes to the plan (within prescribed limits). Earnings accumulate inside the plan on a tax-deferred basis. A 401(k) plan must meet the nondiscrimination requirements of all qualified plans along with certain other unique 401(k) requirements: - Distributions cannot be made based on the completion of a stated period of plan participation or a fixed period of time.
- The employee's rights to elective deferrals must be fully vested at all times.
- Contributions on behalf of highly compensated employees may not exceed specified limitations based on contributions made on behalf of non-highly compensated employees. Deferrals by highly compensated employees are limited by the average deferrals of non-highly compensated employees, and employer matching contribution rules must apply uniformly to all employees.
Withdrawals from a 401(k) account generally are taxed as ordinary income, except to the extent they represent a return of the employee's nondeductible contributions. If withdrawals are taken prior to age 59 1/2, a 10 percent penalty tax also will be levied unless certain exceptions apply. Distributions from a 401(k) account generally must begin no later than April 1 of the year following the year in which the employee reaches age 70 1/2. However, distributions may be deferred until actual retirement, if later than 70 1/2, by employees other than those who own more than 5 percent of the employer that maintains the plan. |
