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401(k) Plan

Key Features

  • Tax deferred
  • Matching employer contributions
  • Excellent retirement investment
  • Non-discrimination rules

A Cash or Deferred Arrangement, also known as a "401(k) Plan", is a type of profit sharing plan under which employees are permitted to defer an elective amount of compensation which is deducted from current taxable income and is contributed to the profit sharing plan on behalf of the participant. Frequently employers provide additional incentive for such employee salary deferrals by offering matching employer contributions which are related to the amount of the employee's salary deferred. Thus the name "cash or deferred arrangement" appearing in Section 401(k) of the Internal Revenue Code refers to the employee's ability to elect to receive his compensation in cash or to defer it into the plan.

401(k) plans are generally appropriate for employers who are unable or unwilling to provide substantial retirement benefits but who desire to allow employees the ability to make contributions in amounts larger than those available to individuals through Individual Retirement Accounts. They are unusually good investments for those employees who are interested in investing for their retirement because it is a way of purchasing investments with pretax contributions and of accumulating their funds tax-free. At retirement, a participant's benefit is equal to the then value of the accumulated investments held on behalf of the participant.

The maximum amount of salary which can be deferred under Section 401(k) of the Code is $10,000 per year, as that amount may be adjusted for cost of living increases. 401(k) plans are subject to strict non-discrimination rules which require that "non-highly compensated" employees participate in the plan at a rate comparable to the rate at which "highly compensated" employees participate. Therefore 401(k) plans exist primarily to benefit the rank and file rather than highly compensated employees.

Because of administrative complexity and nondiscrimination rules associated with this type of program, it is generally a good idea for employers with 50 or more employees.

401(k) Insurance and Investment Links

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