A 401(k) Plan is a cash or deferred pay plan that some companies offer their employees if the company has a profit sharing or stock bonus plan. In a 401(k) plan, employees are given the opportunity to invest in additional tax sheltered pay.
Contributions to the 401(k) plan generally takes the form of salary reduction deferrals although the company may offer to contribute to a 401(k) plan trust account if the employee agrees not to take a salary increase.
Under the salary reduction agreement, the employee elects to contribute a specified amount of pay to the 401(k) plan instead of receiving the wages as regular salary.
The contribution under the salary deduction agreement is treated as a contribution by the employer that is not taxable if the annual contribution limits are not exceeded.
As a result of the elective salary deferrals, the employee is allowed to defer tax on that portion of salary and get a tax free buildup of earnings within the 401(k) account.
There are limits placed on the amount of salary that an employee can contribute to the elective deferrals account that are not subject to income tax withholdings but are subject to Social Security and Medicare withholdings.
Under the 401(k) plan, laws govern the withdrawal of funds from the elective deferrals account. An employee is penalized for withdrawing funds unless:
1.The employee has reached the age of 59 1/2.
2.Financial hardship can be proven.
3.The employee no longer works for the company.
4.The employee becomes totally disabled.
5.If the employee dies, the beneficiary can withdraw the funds.
If the 401(k) plan is terminated and all of the employees funds were pre-tax elective salary deferrals and no successor plan is instituted, the entire distribution becomes taxable unless it is rolled over into another qualified plan.