The 401(k) Plan

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A 401(k) plan is a tax-qualified tax-deferred employer-sponsored retirement plan that an employee may make from their salary. Some employers match your 401(k) contributions up to the amount you invest but most employers don’t come close to that amount. This year the average employer contribution has been 4.7%. 401(k) plans are great ways for employees to earn extra money and what’s great about the savings plans is that you don’t have to pay tax until you withdraw from the account. There are usually limits to the amount of money that a person can contribute to a 401(k) plan. For the 2019 tax year, a person can contribute no more than $19,000. For the 2018 tax year, it was $18,500.

The 401(k) plan was first introduced in 1978 and was originally intended to give employees a break on tax deferred income. The Johnson Companies was the first company to offer 401(k) plans to employees. One big benefit of the 401(k) plan is to defer paying tax to a later time when the income tax is lower. Another benefit of the 401(k) plan is that any gains made in the 401(k) account are not subject to capital gains tax. Two taxes that are not deferred for money going into a 401(k) account are the Social Security tax and the Medicare tax.

When an employee or retiree turns 59 they can start withdrawing money from their 401(k) account without penalty. The only tax they’ll have to pay at that time is the current income tax. If however, they decide to withdraw from their 401(k) account before turning 59 they’ll have to pay an excise tax of 10% of the amount withdrawn. At age 70 an employee or retiree is legally required to start making withdrawals from their 401(k) account. Each year after turning 70 a minimum calculated amount must be withdrawn from the account or a tax penalty is charged at 50% on the amount that needed to have been withdrawn.