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What is 401k Retirement Plan?

401k Retirement Plan


A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section.

U.S. Law: Title 26, Subtitle A, Chapter 1, Subchapter D, Part I, Subpart A, Section 401

What is a 401k?

In simple terms, the 401k retirement plan is a trust in which employees are allowed to contribute money before taxes are assessed. Some employers also provide participants with matching funds to the employee's 401k account as part of their benefits package. The employee may have the option of selecting specific investment options for the money in their 401k account. Besides building retirement funds, contributing to your 401k reduces your taxable income and helps you keep more of your hard-earned money. 401ks are widely regarded as an excellent financial tool and means of building your pension for retirement.

Who can participate?

If your employer offers a retirement plan that qualifies under 401k laws and you are a full-time employee then you may participate.

How does it work?

Generally payments are auto-deducted from your paycheck into your retirement account. Your balance is invested according to the specifications made when you joined the plan. If your employer provides matching funds, this part of your account balance may not be available for some number of years after which it becomes part of your vested balance.

Your 401k money is not taxed until you withdraw it, so if you've retired, you will likely be in a lower tax bracket which results in less money going to the tax man. Also your money grows faster though the power of tax-deferred compounding interest.

Since 401k contributions are typically made directly from your paycheck, saving for retirement is made easy. It is even possible to take out a loan against your 401k account balance, and the best part is that any interest that you would be paying on the loan won't go to a bank, it will be deposited into your account along with the repaid principal. Be sure that you are prepared to leave the money in your 401k retirement plan alone, since there is a 10% penalty for early withdrawal and you will be liable for the deferred income taxes.

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