What is a 401K
This refers to tax delayed retirement plan which is usually savings for an employee. This system of tax plan is available in the United States of America. This can vary from company to company since the management decides the amount of 401K. It is one among the retirement plans but often referred as a definite contribution since the amount is cleared defined. An option is given to the employee when he joins the company to opt for this plan or not, and it entirely depends on the employee’s wish to be a part of it or not.
When an employee wishes to opt for this scheme then he or she tells the employer what is the amount they wish to contribute. This amount is deducted from the salary of the employee before paying taxes; hence the employee pays less tax. This amount is deducted even before the employee gets his or her net pay. Hence it makes it easier for them to know what amount is being saved. Like any other contribution towards retirement plans the employer also contributes a portion towards 401K plan.
The employee is free to discuss with the employer as to where this amount of savings be invested. If there is no communication from them the employer usually invests them in mutual funds, securities, money market etc. Usually the employer will give a list of investments they have and also the risk involved in them. As this is an incentive scheme on retirement the employer will add a condition to it, like if it is withdrawn before the retirement age then the employee will pay taxes on the amount that is deducted.
When an employee opts for 401K plan he or she has a lot of advantages:
- The amount that is contributed by both employer and employee is free from taxes.
- The employee gets the advice of experts in investing the amount contributed in various securities.
- Profit received from investing in money market is also free from the tax bracket.
- The plan also allows an employee to acquire loans.
- It also allows withdrawing some amount on certain conditions.
Many organizations use this 401 K plan as retention technique. They may offer attractive percentage to employees as per the number of years they have spent in the organization. Thus this makes the other employees who have joined recently to think about having a long term relationship with the organization. By this way the management makes an effort to retain its employees for longer period. The employees are usually allowed to contribute anywhere between 1 to 20% of their basic pay.
Again it all depends on the IRS and the company policy as to the percentage of contribution an employee can afford to make towards the 401 K plan.