401(k) Plans

The 401(k) plan has grown to be one of the most popular type of employer-sponsored retirement plans across the country. A vast amount of employees depend on the money they have saved in this plan to provide for their retirement years, and many employers use their 401(k) plans as a means of distributing company stock to employees. A very select amount of plans can match the relative flexibility that 401(k)s offer.

What Is a 401(k) Plan?

By definition, a 401(k) plan is an arrangement that allows an employee to choose between taking compensation in cash or deferring a percentage of it to a 401(k) account under the plan. The amount deferred is usually not taxable to the employee until it is withdrawn or distributed from the plan. However, if the plan permits, an employee can make 401(k) contributions on an after-tax basis (these accounts are known as Roth 401(k)s), and these amounts are generally tax-free when withdrawn. 401(k) plans are a type of retirement plan known as a qualified plan, which means that this plan is governed by the regulations stipulated in the Employee Retirement Income Security Act of 1974 and the tax code.

Qualified plans can be divided two different ways: they can be either defined contribution or defined-benefit (pension) plans. 401(k) plans are a type of defined-contribution plan, which means that a participant's balance is determined by contributions made to the plan and the performance of plan investments. The employer is usually not required to make contributions to the plan, as is usually the case with a pension plan. However, many employers choose to match their employees' contributions up to a certain percentage, and/or make contributions under a profit-sharing feature.