401(k) Plan Basics

Most of us know it is smart to save money for those big-ticket items we really want to buy - a new television or car or home. Yet you may not realize that probably the most expensive thing you will ever buy in your lifetime is your retirement. Perhaps you’ve never thought of “buying” your retirement.

Yet that is exactly what you do when you put money into a retirement nest egg. You are paying today for the cost of your retirement tomorrow.

The cost of those future years is getting more expensive for most Americans, for two reasons. First, we live longer after we retire - with many of us spending 15, 25, even 30 years in retirement - and we are more active. In short, paying for the retirement you truly desire is ultimately your responsibility. You must take charge. You are the architect of your financial future.

What’s a 401(k) plan?

A 401(k) is a retirement savings plan sponsored by an employer. They allow workers to contribute a portion of their wages to a retirement account by payroll deduction. Generally, these deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral and they are not reflected as taxable income on your Form 1040, U.S. Individual Income Tax Return.

Although elective deferrals are not treated as current income for federal income tax purposes, they are included as wages subject to Social Security (FICA), Medicare, and federal unemployment taxes (FUTA). Refer to Publication 525, Taxable and Nontaxable Income, for more information about elective deferrals.

Some 401(k) plans may also permit you to designate some or all of your elective deferrals as Roth elective deferrals, which are generally subject to the same taxation rules as Roth IRAs.

There are several types of 401(k) plans available - traditional 401(k) plans, safe harbor 401(k) plans and SIMPLE 401(k) plans. Different rules apply to each. It is important that you become familiar with your plan so that you understand the special rules that apply to you. This information can be found in your plan’s Summary Plan Description (SPD).

401(k) benefits

Enrolling in a 401(k) plan is one of the best things you can do to save for your future. These plans offer the following benefits:

• Tax credits - Low- and moderate-income workers may be eligible for a Saver’s Credit to help offset part of the first $2,000 they voluntarily contribute to a 401(k) plan.
• Payroll deduction - There are no checks to mail. 401(k) contributions are automatically deducted from your paycheck, making saving for retirement easy.
• Tax-deferred growth - 401(k) money grows tax-free until it’s withdrawn. You never pay taxes on contributions, dividends and capital gains within your 401(k) account.
• Compound interest - The money you save in your 401(k) plan earns interest or investment earnings. When you leave the money there, over time you also earn interest on your interest, or earnings on your earnings - otherwise known as compound interest. When you start saving early, you can see some amazing account growth over the long haul.
• Portability - 401(k) accounts can be rolled into a new employer’s retirement plan or a personal IRA account upon withdrawal.

Additional Information:

• Retirement Toolkit - Developed by the Department of Labor, the Social Security Administration and the Centers for Medicare & Medicaid Services, this toolkit includes a list of publications and interactive tools to help in your planning, plus information on who to contact with specific questions.
• Savings Fitness: A Guide to Your Money and Your Financial Future – This downloadable PDF guide provides an overview on the importance of financial planning to achieve your retirement goals.
• Top 10 Ways To Prepare For Retirement – This easy to read list highlights 10 things to remember when planning for retirement.
• What You Should Know About Your Retirement Plan – A printer-friendly booklet with information on how to monitor your retirement plan and benefits.
• New Employee Savings Tips – Directed at young employees, this information highlights the benefits of retirement planning and encourages them to participate in their company’s plan.