What is a 401(k) Plan?

401(k) plans were not started by the United States government or the Internal Revenue Service for that matter. Instead, 401(k)s were the originated by Ted Benna. After Section 401(k) of the Internal Revenue Code was added in 1978, Benna realized that the provision could be used to create a simple employee retirement plan. Thus the 401k was created.

In 1980, the first 401k was offered. Today, nearly 95% of private employers feature a 401(k) option in their benefits package. They are the single most popular retirement plan in the United States.

As a defined contribution plan, a 401(k) is primarily funded through an employee’s pre-tax paycheck deductions. Some employers offer matching programs for individual contributions, but nearly all 401(k) funding responsibility falls upon each individual account holder.

A 401(k) plan is a qualified plan that includes a feature allowing an employee to elect to have the employer contribute a portion of the employee’s wages to an individual account under the plan. The underlying plan can be a profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan. Generally, deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reported as taxable income on the employee’s individual income tax return. ~ IRS

Private, for-profit employers are the most likely to have 401(k) plans. Non-profit companies may have similar 403(b) plans, while government employers might offer 457(b) plans.

The most important benefit of a 401(k) plan is the possibility of employer match programs, which enable an investor to receive free contributions and exceed standard contribution limits.

There are some notable limitations to 401(k)s — investment options are limited to what a plan provider offers. You simply are prohibited from investing in many asset classes through a 401(k), including real estate and precious metals. The vast majority of 401(k) money is put into mutual funds.

401(k) Plan Rollover Rules & Limitations

If you have a 401(k), you can roll them into an Individual Retirement Account (IRA) or another qualified plan without incurring any tax penalties. Here is an overview of some 401(k) rollover rules:

  • When you receive funds from your 401(k) for a rollover, you have 60 days to complete the process. If you fail to do this, the IRS will treat your money as a taxable distribution. Additionally, if you are not yet 59 ½ years old, the IRS will also impose a 10% penalty on the withdrawal on top of the normal income taxation.
  • You are limited to one rollover per year from a 401(k) into an IRA. This one-year period begins on the date that you receive your 401(k) distribution. This applies separately to each IRA that you own.
  • You cannot use the cash from your distribution to purchase investments in the period in between receiving your 401(k) distribution and establishing your IRA.

We recommend selecting the option to perform a “direct rollover” with your 401(k) funds. In a direct rollover, you never receive a check for your distribution; rather, your 401(k) plan provider will transfer the money directly into you new IRA plan. This is a good way to avoid taxation confusion.

Does Gold and Precious Metals Qualify in 401(k)? Retirement Plan Contribution Chart