401(k) Plan

A 401(k) Plan is an employer-sponsored defined contribution retirement plan. Eligible employees may make salary deferral (direct transfer from one’s pay check) contributions before taxes, thereby reducing taxable income by the amount of the annual contribution.

Employers may choose to make matching or non-elective contributions to the plan on behalf of eligible employees. They may also choose to add a profit-sharing feature to the plan. A common match is 50 cents on the dollar — meaning that for every dollar an employee contributes to his or her 401(k) plan, the employer contributes an additional 50 cents (typically up to a specified maximum amount).

As an example: suppose your employer’s 401(k) plan does, in fact, offer to add 50 cents for every dollar you contribute, up to 6% of your income. If your income is $50,000, then your employer will contribute as much as $1500 per year to your retirement savings — provided you contribute $3000 per year (or more). Because your employer’s contribution is, in effect, free money, you should plan to contribute at least the amount needed to take full advantage of your employer’s matching contribution.

Note that there are Contribution Limits for 401(k) plans:

Age 49 and below: $15,500/year
Age 50 and above: $20,500/year

Also note that the combined contributions of employee and employer must not exceed the lesser of: 100% of employee's salary or $46,000 per year.

Distributions

Money can be withdrawn from a 401(k) beginning at age 59 ½ or if the owner of the account becomes disabled. Early withdrawals are subject to a 10% penalty. Distributions must start by April 1st of the year after one either reaches age 70 ½ or retires, whichever is later. Failing to withdraw the minimum forced distribution amount(s) results in a penalty equal to 50% of that minimum distribution.