The 401(k) is a type of retirement savings account is sponsored by employer.

Employers can help their employees save for retirement while reducing taxable income under this provision, and workers can choose to deposit part of their earnings into a 401(k) account and not pay income tax on it until the money is withdrawn after 59 1/2..

About 60% of American households nearing retirement age have 401(k)-type accounts in 2011. 

Interest earned on money in a 401(k) account is deferred and pay income tax when the funds are withdrawn. Employers may match contributions that workers make.

The 401(k) account is typically administered by the employer, while in the usual "participant-directed" plan, the employee may select from different kinds of investment options. Employees may choose how they invest, mutual funds , stocks, bonds, money market , or some mix of them.

Many companies' 401(k) plans also offer purchase the company's stock option. The employee can generally re-allocate money among these investment choices at any time.

Another type of 401(k) plan has been available since 2006 call Roth 401(K). Employee can allocate some or all of their contributions to a separately-designated Roth account. These "Roth" contributions will be collected and treated as after-tax dollars; that is, income tax is paid or withheld in the year contributed. Qualified distributions from a designated Roth 401(k) account, including all income, are tax-free. (A traditional 401(k) account is tax deductible and withdraw taxable income) .

All employer matching funds are deposited into the account all before tax money, even if the employee's contributions are all Roth contributions.

Contributions: 

Depending on whether the plan allows, employees can make contributions to the 401k on a before tax or after tax basis. With either before tax or after-tax contributions, earnings from investments in a 401(k) account (in the form of interest, dividends, or capital gains) are tax deferred.

 

The resulting compounding interest with delayed taxation is a major benefit of the 401(k) plan when held over long periods of time. Starting in the 2006 tax year, employees can also elect to designate contributions as a Roth 401(k) deduction. Similar to the provisions of a Roth IRA these contributions are made on an after-tax basis and all earnings on these funds not only are tax deferred but could be tax free upon a qualified distribution. However, to do so, the plan sponsor must amend the plan to make those options available.

For before tax contributions, the employee does not pay federal income tax on the amount of current income that he or she defers to a 401(k) account.

If the employee made after-tax contributions to the non-Roth 401k account, these amounts are combine with the before tax funds and simply add to the non-Roth 401(k) basis. When distributions are made the taxable portion of the distribution will be calculated as the ratio of the non-Roth contributions to the total 401(k) basis. The remainder of the distribution is tax free and not included in gross income for the year.

For accumulated after-tax contributions and earnings in Roth 401(k)), "qualified distributions" can be made tax free. In order to qualify, distributions must be made more than 5 years after the first designated Roth contributions and not the account owner turns age 59½, unless an exception applies as detailed in IRS code section 72(t).

 

In the case of designated Roth contributions, the contributions being made on an after-tax basis means that the taxable income in the year of contribution is not decreased as it is with before tax contributions.

Roth contributions are irrevocable and cannot be converted to before tax contributions at a later date. Administratively Roth contributions must be made to a separate account, and records must be kept that distinguish the amount of contribution and the corresponding earnings that are to receive Roth treatment.

There is no upper income limit capping eligibility for ROTH 401k contributions. An individual who finds themselves disqualified from a Roth IRA may contribute to their Roth 401(k). Individuals who qualify for both can contribute the maximum statutory amounts into both plans (including both catch-up contributions if applicable).

Withdrawal of funds 

All employers impose severe restrictions on withdrawals while a person remains in service with the company and is under the age of 59½ or 10% penalty if withdraw before 59½ unless a further exception applies.

IRA Required Minimum Distributions(RMD) 

An account owner must begin withdraw from their accounts by April 1 of the calendar year after turning age 70½ or April 1 of the calendar year after retiring, whichever is later. The amount of distributions is based on life expectancy according to the relevant factors from the appropriate IRS tables. There is an exception to minimum distribution for people still working once they reach that age. The exception only applies to the current plan they are participating in and does not apply if the account owner is a 5% owner of the business sponsoring the retirement plan.

Required minimum distributions apply to both before tax and after-tax Roth contributions. Only a Roth IRA is not subject to minimum distribution rules. Other than the exception for continuing to work after age 70½ differs from the rules for IRA minimum distributions. The same penalty applies to the failure to make the minimum distribution. The penalty is 50% of the amount that should have been distributed, one of the most severe penalties the IRS applies. In response to the economic crisis, Congress suspended the RMD requirement for 2009. 

"Force-out" provision

Former employees can have their 401(k) plans closed if the balance is low. Almost 90% of plans have a force-out provision. As of March 2005, the limit for force-out provisions is a balance of $1,000—a participant whose balance is over $1,000 cannot have their plan terminated. Before March 2005, the limit was $5,000. 

Closing the plan requires that the participant either roll-over the funds to an IRA, another 401(k) plan or take a distribution ("cash out"). 85% of those with balances of under $1,000 cash out, either voluntarily or due to a force-out provision.

Contribution deferral limits 

There is a maximum limit on the total yearly employee before-tax or ROTH salary deferral into the plan. This limit, known as the "402(g) limit", $16,500 for 2009-2011. This has been raised to $17,000 for 2012. For future years, the limit may be indexed for inflation, increasing in increments of $500. Employees who are over age 50 can catch up $5,500 for 2009-2012. The limit for future "catch up" contributions may also be adjusted for inflation in increments of $500. 

 

In eligible plans, employees can elect to contribute on a pre-tax basis or as a Roth 401(k) contribution, or a combination of the two, but the total of those two contributions amounts must not exceed the contribution limit in a single calendar year. This limit does not apply to post-tax non-ROTH elections.

Maximum 401k contribution limit that applies to all employee and employer 401k contributions in a calendar year. This limit is the section 415 limit, which is the lesser of 100% of the employee's total before tax compensation or $49,000 for 2009 through 2011, and $50,000 for 2012. For employees over 50, the catch-up contribution limit is also added to the 415 limit.

Highly compensated employees (HCE) is $110,000 in 2011or no more than 2 percentage points greater (or 125% of, whichever is more) than the non-highly compensated employees (NHCE). 

Governmental employer( federal, state, county, and city governments)can set up a section 457(b) plan for their employee instead of 401(K)

Contribution deadline 

For a corporation, or LLC taxed as a corporation, contributions must be made by the end of a calendar year.

For a sole proprietorship, partnership, or an LLC taxed as a sole proprietorship, the deadline for depositing contributions is generally the personal tax filing deadline April 15 (or 09/15 if an extension was filed).

Fees 

401(k) plans charge fees for administrative services, investment management services, and sometime outside consulting services. They can be charged to the employer, the plan participants or to the plan itself and the fees can be allocated on a per participant basis, per plan, or as a percentage of the plan's assets.

 

For 2011, the average total administrative and management fees on a 401(k) plan was 0.78 percent or approximately $250 per participant.

Plans for certain small businesses or sole proprietorships.