Many employers provide a qualified retirement plan for their employees. The program may be defined as a 401(k), 403(b), 457(b), pension or profit-sharing plan. Some plans are subject to ERISA, which means the Department of Labor has certain jurisdiction over the plan, while other plans are not subject to ERISA and the employer is not required to comply with those regulations. The employer plan can define who is eligible to participate, who will receive certain contributions, the benefits available and the conditions under which those benefits may be paid. Each plan is designed to the unique characteristics of the employer; therefore, one plan may include loans, while another may not. As a participant in the plan, you will receive a Summary Plan Description that provides a "plain language" description of the plan and its provisions. If you have questions regarding your plan, check with your employer's plan representative for assistance.
Today, many employers offer their employees the opportunity to participate in a 401(k) or 403(b) retirement plan. These programs allow participants to defer a portion of their wages before certain income taxes are applied to the paycheck. Contributions are applied to the plan and earnings are applied to the participant's account on a tax deferred basis.
To become a participant in the Plan, the employee must complete a Salary Deferral Agreement, making an election to defer a percentage or a fixed amount to the plan. The election is applied to the payroll program and funds are withheld each time a paycheck is issued.
An employee may generally modify or stop deferrals to the plan periodically during the year. Each plan has the ability to define these dates and participants should check the Summary Plan Description or check with their plan representative to determine the permitted change dates.Many plans allow participants to select the investments for their accounts among a group of mutual funds offered by the Plan. Choosing the appropriate funds depends on each individual's preference or tolerance for risk. A participant who is uncomfortable with fluctuations in their account may elect to invest in more conservative funds than a participant who is content to maintain an investment mix and a program whether the market is rising or falling.
Generally, the plan conducts an enrollment with the assistance of the investment professional selected by the plan sponsor. During these meetings, participants are offered assistance with selection of funds suitable for each individual.Although participant loans are not offered by all plans, many sponsors include the option as a method for employees to save and use those savings to make purchases or pay expenses. Participants electing to take a plan loan are required to pay interest on the principal amount and make scheduled payments to the plan based on the plan's loan policy.
If loans are allowed from the plan participants may generally borrow 50% of the participant's vested account balance, but not more than $50,000. The participant must pay a rate of interest on the loan that is comparable to similar loans issued by financial institutions in the participant's geographical region. Loans must be repaid within 5 years unless the purpose of the loan was to purchase a primary residence.
When taking a loan, participants should read and understand the plan's loan policy. Some plans require that payments must be made through payroll deduction and termination of employment results in a loan that becomes due and payable. Where this is the case, a loan could result in an unexpected taxable event. While the employee can generally rollover a similar amount to an IRA or other qualified plan, the employee must have access to sufficient cash to make the rollover contribution.
A participant may also incur a taxable event if the payments become delinquent. For example, if the individual is required to take a leave from his or her job and payments are not maintained, the plan may be required to treat the loan as a distribution.
A plan sponsor may also elect to permit employees who experience a financial hardship to take a distribution from the Plan. The employer may permit hardship payments from employee deferrals only or include matching and non-elective balances as well.
IRS regulations permit the payment of employee contributions only from the deferral account, i.e., no earnings on deferrals may be paid for hardship. If permitted, all balances from the match or non-elective accounts can be eligible for a hardship distribution.
Regulations permit financial hardship distributions for:
- Purchase of a primary residence
- Post-secondary educational expenses for the participant or a dependent of the participant
- Payment of unreimbursed medical expenses
- Expenses resulting from a natural disaster
- Funeral expenses for the participants or a dependent of the participant
Before a hardship distribution can be made, the participant must receive any available funds available to the participant. This includes any loan that can be received from any plan of the employer unless the loan would create an additional hardship on the participant. Hardship distributions are subject to ordinary income taxes and if the participant is under age 59 1/ 2, an additional 10% penalty may be due.
Various regulations as well as the employer's individual plan document impact the availability of a hardship payment. Check with your plan representative for specific limitations and requirements of the Plan.
With the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), 401(k) and 403(b) plan sponsors can elect to permit employees to make traditional or Roth salary deferrals to their plan. Generally, traditional deferrals to these plans are made on a tax-deferred basis with income and contributions taxed at the time the plan assets are distributed to the employee or beneficiary.
Under a Roth option, participants are allowed to defer the same amount as in a traditional 401(k) or 403(b), but the Roth deferrals are withheld after taxes have been applied to the contribution amount. Deferrals can also be split.
The combined deferral limits for traditional and Roth contributions are the same as the limit for traditional 401(k) or 403(b) deferrals. For 2011, employees able to defer up to $16,500 for tax if a participant is under 50, with additional $5,500 available to individuals who are over age 50.
Although the deferrals to a Roth 401(k) or 403(b) are made with post-tax dollars, the earnings on Roth contributions will be tax free, if distribution is made at least 5 years after the first Roth contribution and the attainment of age 591/2, death, or disability. Roth contributions may be more advantageous to younger workers who are currently taxed in a lower tax bracket, but anticipate being in a higher bracket at retirement. Roth deferrals offer the advantage of tax free distribution. There are several additional considerations for Roth accounts and participants are urged to discuss the option with their tax advisor before making or changing deferrals from the traditional deferral account.
What is a 401(k) Plan?
A 401(k) Plan is a retirement program that permits employees to defer a portion of their pre-tax salary to the plan. The funds are withheld from each pay check and deposited to a trust where the funds are invested.
How much can I defer to my Plan?
The maximum deferral under IRS Regulations for 2011 is the greater of 100% of your salary after the required Social Security taxes have been withheld or $16,500. If you are over 50 years of age you may be able to defer an additional $5,500.
| Plan Limit/Contribution Type | 2008 Limit |
Salary Deferral to 401(k)/403(b)/457(b) |
$16,500 |
Age 50 Catch-up to 401(k)/403(b)/457(b) |
$5,500 |
Age 50 Catch-up to a SIMPLE 401(k) |
$2,500 |
Salary Deferral to SIMPLE Plan |
$11,500 |
Annual Contribution Limit Under IRC §415(c)(1)(A) |
$49,000 |
Can I withdraw my salary deferrals at any time?
No. Generally, you may only withdraw your funds upon termination of employment. Your plan may also have provisions for in-service withdrawals which may allow you to take a withdrawal without terminating your employment. You should consult your Summary Plan Description for the rules applied by your plan.
I am not currently deferring to the 401(k) Plan. When can I change my election?
Your plan contains specific rules with respect to when you can enter or change your elections. Generally, if you elected no salary deferral in a prior period, you may elect to defer again on the next deferral change date. Each plan has a different change date, but generally these windows occur on a monthly or quarterly basis. You should consult your Summary Plan Description for the deferral change dates.
I am currently contributing to my plan, but I am receiving no match from my employer. Is a match not required in a 401(k) Plan?
No. Your employer is generally not required to contribute matching contributions to your account. Matching contributions are optional.
Can I borrow from my 401(k) Account?
Perhaps. All plans do not have loan provisions. If loans are available, the requirements for requesting a loan will be included in your Summary Plan Description and the Loan Policy Statement.
Can I take a Hardship Distribution from my 401(k) Plan?
Perhaps. Hardship withdrawal provisions may or may not be included in your plan. If a hardship is available, the requirements for requesting the distribution will be included in your Summary Plan Description and Hardship Policy Guidelines available from your employer.