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What is a 401k plan? Here Is A Quick Overview

Employer-sponsored retirement plans are generally grouped into two major
categories: defined benefit (DB) and defined contribution (DC). In a DB plan,
the employer promises to pay a defined amount to retirees who meet certain
eligibility criteria. In other words, the plan defines the benefit to be received. In
its most typical form, a DB plan pays a lifetime monthly benefit to retirees who
fulfill specific age and service requirements. Benefits are usually linked to the
amount of service and based on final average salary. Employees can
reasonably rely on a known and expected benefit level, although protection
against post-separation inflation is usually limited and/or uncertain. The plan
sponsor may also provide an alternative lump sum "cash-out" of the benefit
entitlement. Until relatively recent times, the DB was the dominant form of
employer-sponsored retirement program.

In DC plans, the plan defines the contributions that an employer can make, not
the benefit that will be received at retirement. The terminating employee
receives the proceeds in a current or deferred lump sum or annuity. Since the
benefit is not defined, the retirement outcomes are not known in advance.
In 1978, section 401k of the Internal Revenue Code authorized the use of a
new type of defined contribution plan that allows for the employee to make pre-
tax contributions to the plan.

How It Works
Employee 401k contributions are automatically deducted from their paycheck
each pay period. This money is taken out before the employee paycheck is
taxed. The contributions are invested at the employee direction into one or
more funds provided in the plan. Employers often "match" employee
contributions, but are not required to do so. While the investments grow in the
employees 401k account, they do not pay any taxes on it.

Advantages and Benefits
401k plans offer many benefits including the following:
· Any business, whether a C Corporation, S Corporation, partnership, sole
proprietorship, self-employed can establish a 401k Plan.
· The company sets the eligibility requirements, within certain guidelines, at
the time the plan is established.
· Employer can restrict individuals with less than one-year service, union
members, non-US citizens, part-time workers, etc., from being eligible for the
plan.
· Contributions to plan can come from voluntary employee salary
reduction, from employer, or both.
· Each individual employee can defer in 2005 up to $14,000 or 100% of
compensation whichever is less. This will increase $1,000 each year till
$15,000 in 2006.
· Participants age 50 and over can make additional "catch-up"
contributions of $4,000 in 2005, which will increase each year by $1,000 until
$5,000 in 2006.
· Employees are immediately 100% vested with their own salary reduction
tax deferred contributions.
· Employee withdrawals before age 59 1/2 may be subject to 10% penalty.
· Employees who retire any time during the calendar year in which they
turn 55, or later, are not subject to the 10% penalty.
· Employers can establish a vesting schedule, within certain guidelines, for
the contribution the company makes to the 401k.
· Employers are not required nor obligated to make any contribution to the
401k, although employer may have some obligation to contribute if plan is
deemed top heavy.
· Turnkey and Internet based plans are available.
· Excellent range of investment options available for the plan sponsor to
offer within the plan.
· The investment choices in most plans range from 8 to 20 options. The
average plan has about 15.
· 401k plans may permit "self-directed investment accounts" and company
stock purchase within the plan.
· Employee contributions to the plan are not subject to federal income
taxes until a distribution from the plan is made. Any investment gains and
earnings also enjoy tax deferral until distribution.
· This type of plan can permit loans and hardship withdrawals.
· Participants can start, stop contribution during course of year, as
determined by the company.
· The employer can receive certain tax benefits for contributions.
· Plans are subject to top heavy and discrimination testing.
· Typically the amount the owners and highly compensated individuals can
contribute to a 401k is a function of the contributions of the other employers.
· 401k plans can be subject to IRS 5500 filings.
· Generally, the vendor selected by the plan sponsor does all accounting,
participant reporting, testing, and files 5500 reports with the IRS.
401k plans have proven to be popular with employees for several reasons.
The tax deferral is obviously high on this list of reasons. Others include the
increased portability of this plan, employer matching contributions, and the
increased control associated with self-direction of investments.

Starting a Profit Sharing or 401(k) Plan
Starting a plan will help your company stay competitive in today's tight labor
market.
401(k) plans help you:
· Attract and retain the best employees
· Help your employees plan for retirement
· Take control of your own financial future
401(k) plans help your employees:
· Defer federal and, in most cases, state income taxes
· Contribute through automatic payroll deductions
· Simplify investment decisions
· Receive immediate investment return when a company match is available
Today, 401(k) plans are more available, easier to administer and more
affordable than ever before, whether you have 50 or 5,000 employees. In fact:
· Approximately 400,000 companies are already benefiting from 401(k)
plans
· 42 million employees are saving for retirement through company-
sponsored plans
· Americans have more than $1.9 trillion invested in 401(k) plans

Choosing a Plan
There are several types of plans to choose from. Your decision will be based
upon both your own personal goals and your goals for your company. The
following questions will help you identify plans that may best suit your company.
Plan service providers will be able to discuss your needs in detail and help you
decide what type of plan is right for you.

· Do you have fewer than 100 employees and want to make a company
contribution of up to 3% of pay?
Consider the SIMPLE plan.
· Do you want to include employees who work less than 1000 hours a year?

Consider a SEP Plan.
· Do you want contributions to vary according to company profits and be
paid to employees immediately?
Consider a cash profit sharing plan.
· Do you want contributions to vary according to company profits and be
payable upon retirement?
Consider a deferred profit sharing plan.
· Do you want to make contributions with the goal of participants achieving
a specific "target" amount of money at retirement independent of company
profits?

Consider a target-benefit plan or a defined-benefit plan.
· Do you want your employees to be able to defer some of their current
income so they can save in a tax-deferred account?
Consider a 401(k) plan.
· Do you want to match your employees' contribution more than 3%?
Consider a 401(k) plan.
· Do you want to make contributions independent of company profits?
Consider a money purchase plan.

Types of plans

Profit sharing plan
A plan established and maintained by an employer to provide for the
participation in its profits by its employees or their beneficiaries. Company
contributions may be determined either by fixed formula or at the discretion of
the board of directors.

Cash profit sharing plan
Profit sharing plan in which profits are paid directly to employees in cash,
check or stock as soon as profits are determined. (This type of profit sharing
plan is not a qualified retirement plan.)

Deferred profit sharing plan
Profit sharing plan designed to provide benefits upon retirement. Benefits at
retirement are based strictly upon the sum total of the contributions made and
the investment results therein. The plan must provide a definite predetermined
formula for allocating contributions made to the plan participants.

401(k) plan
A defined contribution plan that enables employees to choose between
receiving current compensation and making pre-tax contributions to an account
through a salary-reduction agreement. Employers may also make contributions
to employees’ accounts.

Money-purchase plan
A type of defined contribution plan in which the employer’s contributions are
determined by a specific formula, usually as a percentage of pay. Contributions
are not dependent on company profits.

Target-benefit plan
Contributions are based on an actuarial valuation designed to provide a target
benefit to each participant upon retirement. The plan does not guarantee that
such benefit will be paid; its only obligation is to pay whatever benefit can be
provided by the amount in the participant’s account. It is a hybrid of a money-
purchase plan and a defined-benefit plan.

Simplified employee-pension plan (SEP)
This is essentially an individual retirement account (IRA) to which an employee
and his or her employer may contribute. Any employer contributions are
excluded from an employee’s income.

SIMPLE plan (savings incentive match plan for employees)
A type of pension plan that may be implemented by employers with 100 or
fewer employees in which the employer matches 100% of employee deferrals
up to 3% of compensation or provides non-elective contributions up to 2% of
compensation. These contributions are immediately and 100% vested, and
they are the only employer contribution to the plan. SIMPLE plans may be
structured as individual retirement accounts (IRAs) or as 401(k) plans.

Defined-benefit plan
A type of retirement plan that provides each participant with a fixed income at
retirement.

Buy a copy of:

"Pocket Change And
A Prayer" ISBN-13: 9780595446858

"Financial Planning
For The Not Yet
Millionaire" ISBN-13: 9780595446865

Available in 26,000 bookstores around the world.

Would you like to talk
with a Financial
Planner about your
future retirement
options?
One Hour Retirement Analysis

don@donpbaker.com

- donpbaker commented on Financial Planning and Investments Advice
- 4 days ago
- view story
What is a 401k plan? Here Is A Quick Overview

Employer-sponsored retirement plans are generally grouped into two major
categories: defined benefit (DB) and defined contribution (DC). In a DB plan,
the employer promises to pay a defined amount to retirees who meet certain
eligibility criteria. In other words, the plan defines the benefit to be received. In
its most typical form, a DB plan pays a lifetime monthly benefit to retirees who
fulfill specific age and service requirements. Benefits are usually linked to the
amount of service and based on final average salary. Employees can
reasonably rely on a known and expected benefit level, although protection
against post-separation inflation is usually limited and/or uncertain. The plan
sponsor may also provide an alternative lump sum "cash-out" of the benefit
entitlement. Until relatively recent times, the DB was the dominant form of
employer-sponsored retirement program.

In DC plans, the plan defines the contributions that an employer can make, not
the benefit that will be received at retirement. The terminating employee
receives the proceeds in a current or deferred lump sum or annuity. Since the
benefit is not defined, the retirement outcomes are not known in advance.
In 1978, section 401k of the Internal Revenue Code authorized the use of a
new type of defined contribution plan that allows for the employee to make pre-
tax contributions to the plan.

How It Works
Employee 401k contributions are automatically deducted from their paycheck
each pay period. This money is taken out before the employee paycheck is
taxed. The contributions are invested at the employee direction into one or
more funds provided in the plan. Employers often "match" employee
contributions, but are not required to do so. While the investments grow in the
employees 401k account, they do not pay any taxes on it.

Advantages and Benefits
401k plans offer many benefits including the following:
· Any business, whether a C Corporation, S Corporation, partnership, sole
proprietorship, self-employed can establish a 401k Plan.
· The company sets the eligibility requirements, within certain guidelines, at
the time the plan is established.
· Employer can restrict individuals with less than one-year service, union
members, non-US citizens, part-time workers, etc., from being eligible for the
plan.
· Contributions to plan can come from voluntary employee salary
reduction, from employer, or both.
· Each individual employee can defer in 2005 up to $14,000 or 100% of
compensation whichever is less. This will increase $1,000 each year till
$15,000 in 2006.
· Participants age 50 and over can make additional "catch-up"
contributions of $4,000 in 2005, which will increase each year by $1,000 until
$5,000 in 2006.
· Employees are immediately 100% vested with their own salary reduction
tax deferred contributions.
· Employee withdrawals before age 59 1/2 may be subject to 10% penalty.
· Employees who retire any time during the calendar year in which they
turn 55, or later, are not subject to the 10% penalty.
· Employers can establish a vesting schedule, within certain guidelines, for
the contribution the company makes to the 401k.
· Employers are not required nor obligated to make any contribution to the
401k, although employer may have some obligation to contribute if plan is
deemed top heavy.
· Turnkey and Internet based plans are available.
· Excellent range of investment options available for the plan sponsor to
offer within the plan.
· The investment choices in most plans range from 8 to 20 options. The
average plan has about 15.
· 401k plans may permit "self-directed investment accounts" and company
stock purchase within the plan.
· Employee contributions to the plan are not subject to federal income
taxes until a distribution from the plan is made. Any investment gains and
earnings also enjoy tax deferral until distribution.
· This type of plan can permit loans and hardship withdrawals.
· Participants can start, stop contribution during course of year, as
determined by the company.
· The employer can receive certain tax benefits for contributions.
· Plans are subject to top heavy and discrimination testing.
· Typically the amount the owners and highly compensated individuals can
contribute to a 401k is a function of the contributions of the other employers.
· 401k plans can be subject to IRS 5500 filings.
· Generally, the vendor selected by the plan sponsor does all accounting,
participant reporting, testing, and files 5500 reports with the IRS.
401k plans have proven to be popular with employees for several reasons.
The tax deferral is obviously high on this list of reasons. Others include the
increased portability of this plan, employer matching contributions, and the
increased control associated with self-direction of investments.

Starting a Profit Sharing or 401(k) Plan
Starting a plan will help your company stay competitive in today's tight labor
market.
401(k) plans help you:
· Attract and retain the best employees
· Help your employees plan for retirement
· Take control of your own financial future
401(k) plans help your employees:
· Defer federal and, in most cases, state income taxes
· Contribute through automatic payroll deductions
· Simplify investment decisions
· Receive immediate investment return when a company match is available
Today, 401(k) plans are more available, easier to administer and more
affordable than ever before, whether you have 50 or 5,000 employees. In fact:
· Approximately 400,000 companies are already benefiting from 401(k)
plans
· 42 million employees are saving for retirement through company-
sponsored plans
· Americans have more than $1.9 trillion invested in 401(k) plans

Choosing a Plan
There are several types of plans to choose from. Your decision will be based
upon both your own personal goals and your goals for your company. The
following questions will help you identify plans that may best suit your company.
Plan service providers will be able to discuss your needs in detail and help you
decide what type of plan is right for you.

· Do you have fewer than 100 employees and want to make a company
contribution of up to 3% of pay?
Consider the SIMPLE plan.
· Do you want to include employees who work less than 1000 hours a year?

Consider a SEP Plan.
· Do you want contributions to vary according to company profits and be
paid to employees immediately?
Consider a cash profit sharing plan.
· Do you want contributions to vary according to company profits and be
payable upon retirement?
Consider a deferred profit sharing plan.
· Do you want to make contributions with the goal of participants achieving
a specific "target" amount of money at retirement independent of company
profits?

Consider a target-benefit plan or a defined-benefit plan.
· Do you want your employees to be able to defer some of their current
income so they can save in a tax-deferred account?
Consider a 401(k) plan.
· Do you want to match your employees' contribution more than 3%?
Consider a 401(k) plan.
· Do you want to make contributions independent of company profits?
Consider a money purchase plan.

Types of plans

Profit sharing plan
A plan established and maintained by an employer to provide for the
participation in its profits by its employees or their beneficiaries. Company
contributions may be determined either by fixed formula or at the discretion of
the board of directors.

Cash profit sharing plan
Profit sharing plan in which profits are paid directly to employees in cash,
check or stock as soon as profits are determined. (This type of profit sharing
plan is not a qualified retirement plan.)

Deferred profit sharing plan
Profit sharing plan designed to provide benefits upon retirement. Benefits at
retirement are based strictly upon the sum total of the contributions made and
the investment results therein. The plan must provide a definite predetermined
formula for allocating contributions made to the plan participants.

401(k) plan
A defined contribution plan that enables employees to choose between
receiving current compensation and making pre-tax contributions to an account
through a salary-reduction agreement. Employers may also make contributions
to employees’ accounts.

Money-purchase plan
A type of defined contribution plan in which the employer’s contributions are
determined by a specific formula, usually as a percentage of pay. Contributions
are not dependent on company profits.

Target-benefit plan
Contributions are based on an actuarial valuation designed to provide a target
benefit to each participant upon retirement. The plan does not guarantee that
such benefit will be paid; its only obligation is to pay whatever benefit can be
provided by the amount in the participant’s account. It is a hybrid of a money-
purchase plan and a defined-benefit plan.

Simplified employee-pension plan (SEP)
This is essentially an individual retirement account (IRA) to which an employee
and his or her employer may contribute. Any employer contributions are
excluded from an employee’s income.

SIMPLE plan (savings incentive match plan for employees)
A type of pension plan that may be implemented by employers with 100 or
fewer employees in which the employer matches 100% of employee deferrals
up to 3% of compensation or provides non-elective contributions up to 2% of
compensation. These contributions are immediately and 100% vested, and
they are the only employer contribution to the plan. SIMPLE plans may be
structured as individual retirement accounts (IRAs) or as 401(k) plans.

Defined-benefit plan
A type of retirement plan that provides each participant with a fixed income at
retirement.

Buy a copy of:

"Pocket Change And
A Prayer" ISBN-13: 9780595446858

Or

"Financial Planning
For The Not Yet
Millionaire" ISBN-13: 9780595446865

Available in 26,000 bookstores around the world.

Would you like to talk
with a Financial
Planner about your
future retirement
options?
One Hour Retirement Analysis

don@donpbaker.com
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