401 (k) Retirement Plan: What is it?

Don’t let the cryptic name of the plan confuse you, this plan is actually fairly easy to understand. A 401(k) is a retirement plan offered and set up by some employers in the United States and each company has a slightly different 401(K). This is part of a family of retirement plans known as "defined contribution" plans - the amount contributed is defined by the employer or the employee. The plan gets its name from the section and paragraph of the Internal Revenue Code - section 401, paragraph K.

In addition to reducing your tax liability through contributions, the money that is saved in the plan can earn interest and continue to grow tax-deferred. You are only taxed on the money you withdraw from the plan at a later date as ordinary income.

Some companies offer an additional benefit in these plans in the form of a company match. This means your employer will contribute additional money into your plan that matches a portion of your contributions. Some employers match dollar-for-dollar up to a certain percentage of pay while others match a specified percentage of your contribution.

In addition, the company may have a vesting schedule in place that requires you to work for the company for a given length of time before you can collect the matched money. The vesting period can be on a graduated scale or a one-time length of service requirement.

A 401(k) plan allows you to invest money for retirement in a number of ways. These may include mutual funds that invest in the stock, bond or money markets, annuities or guaranteed investment pools, company stock or even self-directed brokerage accounts. Most plans will offer a selection of various investment options that will allow you to create a suitable retirement portfolio.

Money can generally be withdrawn from a 401(k) on five different occasions:

• Termination of employment
• Disability
• Reaching age 59 ½ (or 55 in some cases)
• Retirement
• Death

It is important to note that in some cases if money is withdrawn from these accounts before reaching age 59 ½ the IRS will issue a 10% early withdrawal penalty. Outside of the five qualified distribution events you may be able to access a portion of your money if your plan allows loans.