Many retirees are familiar with 401(k) plans. Also known
as salary reduction plans, a 401(k) plan is a form of defined
contribution profit sharing plan that allows for salary deferral
contributions. It is a systematic way for employees to save for
their own retirement. Many businesses now offer 401(k) plans as
the primary retirement savings option for their employees. Many
companies match a portion of their employees' contributions to a
401(k) plan or make employer profit sharing contributions.
401(k) plans have the potential to be very effective in building long-term retirement savings because of their excellent tax advantages. Contributions are made on a pre-tax basis. This means that no federal income tax, and in most cases no state or local
income tax, is due on
employee contributions
; and no federal, state or local income tax is due on
employer
contributions. All
investment earnings accumulate tax deferred until funds are
withdrawn from the plan.
You cannot continue to contribute to your 401(k) plan
after retirement. But as a retiree, you can remain in the plan and
probably continue to choose how your money is invested.
You also can withdraw your entire account balance
(including your employer's contributions). Withdrawals are
usually made at retirement or termination of employment. If the
withdrawal is not rolled into an IRA or another qualified plan,
the employee will have to pay taxes and possibly a 10% penalty on
the entire withdrawal if made prior to age 59-1/2. Before you
withdraw funds, it's wise to consult a financial advisor.
Employee salary deferral contributions to a 401(k) plan
reduce an employee's amount of current taxable income. That
creates additional savings. Also, the distribution received at
retirement may be taxed at a lower rate than when the employee was
working. Some 401(k) plans now have a Roth option, called a "Roth 401(k)."
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