Contrary to popular belief a 401(k) plan is not a plan at all, but rather it is a feature within a profit sharing plan that allows you to make contributions on a tax preferred basis, which also accumulate tax-deferred for your retirement. 401(k) plans get their name from the Internal Revenue Code Section 401(k), which allows for pretax voluntary savings. In addition to the pre-tax contributions, the investment earnings also accumulate tax deferred until paid out at retirement.

There are many reasons for the popularity of 401(k) plans, but the one reason which employees appreciate the most is their personal involvement. In older types of retirement plans the company made all the decisions.

Now the employee decides –

• First, by electing to defer salary pre-tax which is deposited into your 401(k).
  
  
• Second, by choosing investments, among those offered by the Plan, to tailor your 401(k) Plan to meet your personal objectives.
  
  
• Third, by allowing daily access to your account to monitor your investments.

• 401(k) plans are named after the IRS Code Section 401(k), which allows for voluntary pre-tax savings. This means that you don’t pay federal and state tax on the money you contribute to the plan.
  
  
• The investment earnings accumulate tax deferred, as with all other types of IRS qualified plans, until paid out at retirement.

• Some companies match the contributions of their employees. Usually this match is a portion of what the employee contributes up to a certain level.
  
  
• Some companies also contribute additional amounts called profit sharing contributions. These contributions are made regardless of how much, if any, their employees contribute and are allocated based on salary.

Every plan has optional eligibility requirements, which were selected by your employer when the Plan was established.  The maximum eligibility waiting period is one year and age 21. 

After you meet the eligibility requirements in your Plan, you are able to enter the Plan on the next entry date, again as selected by your employer.  Entry dates are based on the plan year (i.e. 1/1 – 12/31 or 7/1 – 6/30).  If your plan year is on a calendar year, entry dates could be 1/1 or 7/1 if dual entry, or 1/1, 4/1, 7/1 or 10/1 if quarterly entry.  Some plans have monthly or even immediate entry.  Please refer to the Plan Information option under the “Retirement Planning” tab after you login to your account.

Vesting means that the money you have in the Plan belongs to you and cannot be taken away, or forfeited, if you leave your employer.

Your personal 401(k) contributions and earnings are fully vested at all times – this is your money.  The contributions your employer makes (either matching or profit sharing) may be subject to a “vesting schedule” established by the Plan.

Beginning in 2002, matching contributions must be vested under a more rapid schedule than other types of employer contributions.

The two options for the least rapid vesting schedules beginning in 2002 are:

Minimum Vesting Schedules

	Graded Vesting Schedule Alternative
Years of Service	Matching %	Profit Sharing %
less than 2	0%	0%
2	20%	0%
3	40%	20%
4	60%	40%
5	80%	60%
6	100%	80%
7 or more	100%	100%
	Cliff Vesting Schedule Alternative
less than 3	0%	0%
3	100%	0%
4	100%	0%
5 or more	100%	100%

Usually an employer will only pick one vesting schedule even if it makes both matching and profit sharing contributions.  If your Plan has matching contributions and only one schedule, it would be at least as fast as the Matching % shown above.

Vesting protects your account if you quit, get laid off or fired.

Once eligible, you contribute to the 401(k) Plan through payroll deduction. These contributions are “pre-tax,” that is, they are deducted from your gross income before federal and state taxes are calculated. Generally, your gross earnings, including regular pay, overtime, bonus, etc. is considered when figuring the amount of your 401(k) contribution.

When computing your federal and state taxes, your 401(k) contributions are deducted from your gross earnings. Social Security taxes are paid on your gross salary (including 401(k) deferrals). Therefore, your Social Security taxes and benefits are not affected by your 401(k) participation. By contributing pre-tax, the government actually pays you to save by reducing the taxes you pay.

Your employer will have you complete an election form specifying the percentage of your gross salary you want to contribute to the 401(k) plan. Some Plan Sponsors allow on-line enrollment or by phone.

Most Plans usually specify certain percentage limits on what you can contribute. For example, a lot of plans allow you to contribute between 1% and 15% of your gross salary. These plan restrictions may be removed in the near future, because in 2002, the law changed to allow employees to contribute up to 100% of your salary. In addition to your Plan’s limits the IRS places a cap on the maximum dollar amount you can contribute in a calendar year. Beginning in 2002, an additional pre-tax catch-up contribution can be made if you are age 50 or older.

The maximum dollar amounts and catch-up contributions are:

Calendar Year	Dollar Maximum	Additional Amount Age 50 or Older
2001	$10,500	N/A
2002	$11,000	$1,000
2003	$12,000	$2,000
2004	$13,000	$3,000
2005	$14,000	$4,000
2006	$15,000	$5,000

As you can see, this new law increases the maximums so that almost everyone can contribute as much as they want.

Yes!

The federal and state governments provide tax incentives to encourage you to save for your retirement. That is:

1. You don’t pay federal and state tax on your contributions when they are made to the 401(k) Plan, and
   
   
2. You don’t pay federal and state tax on the investment earnings on your 401(k) savings as they accumulate for your retirement.

Because your contribution and the investment earnings are not currently taxed, you pay less federal and state taxes. In other words, the federal and state governments actually pay you to save. Because your account compounds tax deferred, you can build savings faster in the 401(k) Plan.

Look at the value of the tax deferred advantage:

No! Employer contributions to a 401(k) plan are optional. Some employers “match” the contributions their employees make. The matching contributions are usually a portion of the employee’s 401(k) contributions subject to a cap. If made, these matching contributions are usually invested along with the 401(k) contributions.

Also, employers may make an additional profit sharing contribution. Profit sharing contributions, sometimes called employer discretionary contributions, are usually invested annually at the end of the plan year and are allocated based on your salary.

A matching contribution is an employer contribution that is based on the amount you contribute to the 401(k). Many employers commit to matching a fixed percentage of your 401(k) contributions up to a limit. For example, popular matching rates are 25 cents per dollar up to your savings rate of 6% of salary or 50 cents per dollar up to your savings rate of 4% of salary.

Sometimes the employer match is discretionary. That is, the company decides from year-to-year how much to match.

Examples of Popular Matches Based on $24,000 annual salary
		Company Matching Contribution
Percent of Salary	401(k) Contribution	25¢/dollar up to 6%	50¢/dollar up to 4%
2%	$480	$120	$240
4%	$960	$240	$480
6%	$1,440	$360	$480
8%	$1,920	$360	$480

If your employer matches your 401(k) contribution these are usually invested in your account along with your contribution. However, some employers only match at the end of each calendar quarter or even at the end of each year.

It depends, you will need to check with your plan representative. Not all plans allow loans to participants. Loans require your employer to administer loan applications, repayments and defaults. Not all employers are willing to do this.

If your Plan allows for loans, it has a specific loan policy which explains how loans in your plan operate. In addition to your Plan’s requirements, there are many legal restrictions on loans. Your Plan may allow you to borrow for any reason. But, on the other hand, some plans allow loans only if you have a financial hardship as defined by the IRS:

• Unreimbursed medical expenses
• Purchase or rehabilitation of your primary residence
• College tuition/room and board
• Amounts necessary to prevent eviction

Loans are non-taxable distributions, which must be repaid. Generally, loans have to be repaid in quarterly installments within five years by payroll deductions. Most loan policies require full repayment when you leave employment. You should understand your Plan’s loan policy before you borrow.

The law dictates that participant loans meet many requirements. The law mandates that loans must –

• be available to all participants on a reasonable basis,
• not be more than the legal maximum,
• be secured by the participant’s vested interest in the plan,
• charge a reasonable rate of interest,
• be repaid in level installments, and
• be repaid over five years or less, unless made for principal residence.

As you can see there are numerous requirements loans must satisfy. Therefore, you should review your Plan’s loan policy closely before you borrow.

If your plan allows for loans, it also can establish the loan limits but most plans use the rules dictated by the government to calculate the maximum loan amount.

Legally, you can borrow up to one-half of your vested account balance. However, there is also a dollar maximum which limits any loan to $50,000 less the largest loan balance you’ve carried in the last 12 months.

For example, if your account looked like the following:

Source of Money	Account Balance	Vested %	Vested Balance
401(k) Employer Match	$10,000    2,500 $12,500	100% 40%	$10,000    1,000 $11,000

The maximum you could borrow is $5,500 (i.e. ½ x $11,000).

If your highest loan balance during the last 12 months was $10,000 and your account balance looked like the following:

Source of Money	Account Balance	Vested %	Vested Balance
401(k) Employer Match	$100,000    25,000 $125,000	100% 100%	$100,000    25,000 $125,000

The maximum you could borrow is $40,000, the smaller of (a) or (b):

(a)         $50,000 – highest loan =$50,000 - $10,000 = $40,000

(b)      ½   x $125,000 = $62,500

Remember your loan policy may provide additional restrictions besides these legal limits, such as, not allowing loans from company stock accounts.

Most plans allow for distributions as soon as possible following your separation from service. However, if your vested account balance is greater than $5,000, you are not required to take a distribution. A plan can delay distribution until your normal retirement date. When you are entitled to payment, you receive all of your contributions and earnings plus the vested portion of the company's contribution. Generally the full value of your account, including your contributions, plus any company contributions and all investment earnings, will be paid to you if:

• You retire according to the provisions of the Plan,
• You become disabled while in service, or
• You die while in service. In this case, your beneficiary will receive the full balance of your account.

Like loans, hardship withdrawals are allowed by law, but your employer is not required to provide for them in your plan. If your plan allows for hardship withdrawals, you can qualify only if you need the money for one of the following reasons:

1. Payment of medical expenses incurred by the participant, his spouse or dependents or costs involved in obtaining medical care for such persons;
2. Purchase of a principal residence of the participant;
3. Payment of tuition, related educational fees and/or room and board expenses for the next twelve months of post secondary education for the participant, his spouse, children or dependents;
4. Payment of amounts necessary to prevent the participant's eviction from his principal residence or foreclosure on the mortgage of such residence.

The test to determine necessity requires that:

1. The withdrawal must not exceed the amount necessary to satisfy the financial need;
2. All withdrawals and nontaxable loans from all plans of the employer must have been made;
3. All plans of the employer must provide that the maximum elective deferrals that a participant can make in the following taxable year is reduced by the amount of elective deferrals in the taxable year of the hardship distribution;
4. All plans of the employer must provide that a participant is prohibited from making elective deferrals for at least six months after receipt of hardship distribution.

Hardship distributions are subject to income taxes plus the 10% early withdrawal penalty tax.