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What is a 401(k) plan?
A 401(k) plan is a type of qualified retirement plan. Qualified
retirement plans are savings plans that receive special tax treatment
in exchange for meeting numerous requirements spelled out in the
Internal Revenue Code. Qualified plans are also subject to ERISA
(Employee Retirement Income Security Act of 1974) and the regulations
adopted by the Department of Labor under that law.
Who uses 401(k) plans?
A 401(k) plan is provided by an employer, who becomes the plan sponsor.
An employee who is enrolled in a 401(k) is called a plan participant.
401(k) plans are used by businesses of all sizes, from small, unincorporated
companies to large multinational corporations. They are established
for many different reasons and have become quite common as an added
benefit for both employers and employees.
401(k) plans are also appropriate
for employers who want to offer a retirement plan to their employees
and at the same time, allow employees to share the responsibility
of funding the plan.
Why do employers use 401(k) plans?
One of the main reasons employers elect to establish retirement
plans is the tax benefits offered by these plans. Employers are allowed
a current federal tax deduction for contributions made to a qualified
plan. Plan participants pay no current federal income tax on amounts
contributed on their behalf until they begin withdrawals.
Lump-sum
distributions may be eligible for favorable tax treatment, such
as ten-year forward averaging. Participant contributions made to
the plan accumulate income and capital gains, tax-deferred. Tax deferral
means that a participant pays no income tax on the interest, dividends,
or capital gains earned by the plan until they're withdrawn. These
benefits are enjoyed by all qualified retirement plans, including
401(k) plans.
The 401(k) plan offers the additional advantage of
allowing participants to reduce the amount of their incomes subject
to current federal income tax by the amount deferred to the plan.
The ability to reduce their taxable income by participating in
salary deferrals can save employees substantial amounts in income
taxes each year. There are also important non-tax reasons to establish
a 401(k) plan.
Employees have come to view employer-sponsored
retirement plans, and 401(k) plans in particular, as a requisite
job benefit. This perception allows employers to use the 401(k)
plan as an effective means of attracting employees and minimizing
turnover. Productivity gains may also be possible in plans that tie
employer contributions to profitability.
Contact us to find out more about the 401(k). Our registered representatives
are here to help you identify and achieve your financial goals.
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