401k

A 401k is an employer-sponsored retirement plan that allows employees of participating companies to save and invest for their retirement. You authorize your employer to deduct a certain amount from each paycheck, before taxes are taken out, in order to deposit the money in a tax deferred retirement account. A 401k is only available through an employer. If an individual is self-employed he/she may set up a 401k as well, but the contribution limits change. The employer is responsible for setting up the structure of the plan. No income tax is withheld from the earnings withdrawn for the purpose of contribution to the 401k, on the year the contribution is made.

In participant-directed plans, you then decide which of the options, offered by your employer’s plan, you would like to invest in. they can include, mutual funds that focus on money market investments, stocks, bonds, or any assortment of these, including stocks from the sponsoring company. Generally you can change how you would like your investments distributed at any time. There is another plan called a trustee-directed plan in which a trustee, appointed by the employer, makes all the investment decisions.

The maximum allowed for deferral in 2007 is $15,500 to be indexed for inflation every year. The increase for inflation is $500 a year after 2007. If you turned 50 in 2007 or older than you are allowed to contribute an extra $5,000 of pre-tax, catch-up contribution. If you go over your limit for yearly contributions you must withdraw it before April 15th of the following year or pay a penalty. But the main advantage to 401k is the tax deferral. The contributions are taken out before your taxes are calculated so you pay taxes on less income and you can deferrer your taxes until you withdraw the money from the 401k, when you are in a lower tax bracket and can keep more of your money. In order to avoid hefty fines and taxes you should not withdraw from your 401k until after you are 59 ½ years old and no longer in the employment of the company.  There are allotments for expenses due to hardship but you will need to check with your employer to see how they apply to you.