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Although a 401k plan is complex, it is quite easy to understand the plan facts so there is no need to worry.
401k Plan Facts
A 401k plan is an employer sponsored retirement plan. However, employees have to contribute to the plan on a pre-tax basis. The maximum yearly contribution to the plan is limited by the federal government and the plan. In many instances, the employer also contributes matching funds to the account.
Usually the employee decides what percentage of his income he wants to contribute to the 401k plan. This type of plan is known as defined contribution plan. Once the employee retires, the money he gets from the 401k depends on how the plan has grown over the years. That is why it is important for the employee to choose the funds within the plan wisely and carefully.
If you withdraw money from your 401k before attaining the age of 59 1/2, a 10 percent penalty is levied for early withdrawal. In addition, you will also have to pay federal and state income taxes.
If your company offers a 401k retirement savings plan, you will have the option of selecting the funds from the list provided to you by the company. Once you have made your selection, your contribution will be automatically deducted from your salary before taxes. The employer’s matching contribution along with your contribution is then invested in the funds selected by you.
A 401k plan also has a vesting period wherein you will have to be employed for a certain number of years before you can own the entire money in your account. This is true for employer’s matching contribution. In contrast, your contribution to the plan is vested immediately.
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