What is a 401(k) Plan?
A 401(k) plan is a tax-advantaged retirement savings account offered by employers to help employees save for retirement. Named after a section of the U.S. Internal Revenue Code, it allows workers to contribute a portion of their salary to an individual account on a pre-tax or post-tax basis.
How It Works
Employees can choose to defer a percentage of their paycheck into the 401(k) plan. Contributions made on a pre-tax basis reduce the employee's taxable income for the year. Investments within the account grow tax-deferred until withdrawal, usually during retirement when an individual may be in a lower tax bracket.
Employer Contributions
Many employers offer matching contributions, providing an incentive for employee participation. For example, an employer might match 50% of employee contributions up to a certain percentage of their salary, which can significantly enhance savings.
Withdrawal Rules
Withdrawals from a 401(k) before the age of 59½ may incur penalties and taxes. However, there are exceptions, such as financial hardship or specific circumstances like buying a home. After retirement, funds can be taken as lump-sum distributions or through periodic withdrawals.
Importance in Estate Planning
In the context of estate planning, understanding your 401(k) is crucial. It can be a significant asset in your estate, and proper beneficiary designations can ensure that these funds are passed on according to your wishes, avoiding unnecessary taxes and penalties.