401(k) Plan

Definition

The Internal Revenue Code allowed for-profit businesses to establish 401(k) plans as part of a salary-reduction effort that started back in 1978.  Since then, 401(k) plans have grown rapidly in popularity and are now the most common form of a defined contribution retirement plan.

Explanation

Tax-deferred contributions can be made to 401(k) plans as well as after-tax contributions.  Most employers match at least a portion of their workers' contributions to encourage participation.  Plan accounts grow on a tax-deferred basis until withdrawn.  Roth 401(k) contributions, introduced in 2006, are not taxed when withdrawn.

Money placed into the account can be professionally managed or directed by the accountholder to investments selected by the plan's administrator.  Investments typically consist of mutual funds and / or stable value securities.

For the calendar year 2016, an employee can contribute up to $18,000 on a pre-tax basis, which is the same as the $18,000 limit that applied in 2015.  Workers age 50 or more by December 31st are eligible for an additional catch-up contribution of $6,000 in 2016, which is the same as the $6,000 limit in 2015.

The IRS has established rules for both plans and participants.  These rules include contribution limits, withdrawals, minimum distributions, highly-compensated employee participation, and rollovers.  Our article 401(k) plans has up-to-date information on both contributions as well as plan rules.

Related Terms

403(b) plan, employee benefits, individual retirement account, qualified plan