A 401K plan is a qualified salary deferral retirement plan under IRS Code Section 401(k). The 401k plan is becoming the dominant retirement plan for U.S. businesses.
The 401k salary deferral by the employee is not subject to income tax in the year of deferral. This is known as a pre-tax retirement deduction.
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Tax Benefits Of a 401k Plan
401k Maximum Contribution Limits
You should try to contribute as much as possible every year to your 401k plan. You will be decreasing your current year income taxes and forcing yourself to save for your retirement.
It is especially important when your employer has a 401k matching plan -- that is really free money to you, don't turn it down.
The 401k plan documents will specify your rights as to how your contributions may be invested. All 401k plans are different as to these options.
If you don't know anything about investing, you should seek some competent advice. When investing 401k assets or any retirement money, it is always best to be cautious and not be overly aggressive.
Your investment options will probably include money market funds, stock funds, mutual funds, capital stock of your employer and other investments.
Generally, investing too much in the capital stock of your employer is not a good idea.
A "qualified" retirement plan is simply one that has been set up according to the laws and regulations of the Internal Revenue Service (IRS).
The term "401(k)" refers to the code section of the Internal Revenue Code that allows for the establishment of 401k salary deferral retirement plans.
The employee can elect to defer (not receive) a portion of their salary. This deferred salary is then deposited into the employer's 401K plan.
It is then invested according to the rules of the plan. The employer as a benefit to the employee, has the option of matching a portion of the salary deferral.
The IRS has instituted yearly limits as to how much salary an employee can contribute to a 401k plan.
You can contribute up to $18,500 for 2018. If you are age 50 or older in 2018, you can contribute an additional $6,000 for a total of $24,500
For 2019 the limits have increased to $19,000. If you are age 50 or older in 2019, you can contribute an additional $6,000 for a total of $25,000.
401k Maximum Contribution Limits For 2018 and 2019
What is a 401k Retirement Plan?
The matching portion becomes an income tax deduction for the employer.
Most employers make some type of matching contribution but generally they are not required to do so by the IRS.
Even though you participate in a 401k plan, you still may be able to contribute to an IRA. 401k salary deferral plans are just not for large corporations. Your small business, whether it be a self-employed sole proprietorship; a small corporation; or a partnership may establish a 401k plan.
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401k Income Taxes - Social Security & Medicare Taxes
The employee on his Federal income tax return will only report as wages the lesser amount after the salary deferral. The salary deferral though is subject to social security and medicare taxes.
The 401k salary deferral will only be subject to income taxes when the employee withdraws money from the 401k plan and does not make a timely 401k rollover.
Most states that have an income tax also will not tax the 401k salary deferral in the year of deferral. There are also some states that do not tax any type of retirement distribution regardless of when received.