What is a 401(k) plan?

A 401(k) plan is a retirement savings plan that is funded by employee contributions with matching contributions from the employer. The main attraction of these plans is that they are taken from salary before taxes and the funds grow tax-free until withdrawn.

Benefits of 401(k) Plans

The following are the advantages of 401(k) plans:

• Since the employee is allowed to contribute to their 401(k) with money before taxes, it reduces the amount of taxes paid out of each paycheck.
• All employer contributions and any capital growth grow tax-free until retirement. There is a compounding effect of consistent periodic contributions that is quite dramatic over a period of 20 or 30 years.
• The employee can decide where to direct future contributions and/or current savings, giving the employee a lot of control over investments.
• If your company coincides with yours, it’s like getting extra money on top of your salary.
• Unlike a pension, all contributions can be rolled over from one company’s plan to the next company’s plan (or to an IRA) if a participant changes jobs.
• Since the program is a personal investment program for your retirement, it is protected by the pension laws (ERISA). This includes additional protection of funds from garnishment or garnishment by creditors or assigned to anyone else, except in the case of domestic relations court cases dealing with divorce decrees or child support orders.
• Although the 401(k) is similar in nature to an IRA, an IRA will not enjoy matching contributions from the business, and personal IRAs are subject to much lower limits.

Disadvantages of 401(k) Plans

The following are the disadvantages of 401(k) plans:

• It’s difficult and expensive to access your 401(k) savings before age 59½.
• 401(k) plans cannot afford to be insured by the Pension Benefit Guaranty Corporation (PBGC).
• They are generally not acquired (that is, they do not become the property of the employee) by the employer matching them until several years have passed. The rules say employer matching contributions must be awarded according to one of two schedules, either a 3-year “cliff” plan (100% after 3 years) or a 6-year “graduated” plan (20% after 3 years). year in years 2 to 1). 6).

401(k) plans have proven popular with employees for a number of reasons, including tax deferral, greater 401(k) portability, employer matching contributions, and greater control associated with self-directing investments.