The 401(k) plan continues to be, by far, the most popular company-sponsored retirement plan in the land. And it’s no wonder. This unique retirement-saving vehicle offers tax advantages to employees and can also be a valuable tool for employers looking to recruit and retain top talent.
The basic premise is simple: You arrange to have a portion of your pre-tax salary deposited in a separate account. Frequently, an employer will agree to match each dollar that plan participants contribute, up to a specified percentage of compensation. For example, if you earn $100,000 and put $10,000 a year into your 401(k), your company, providing a 3% match, would kick in another $3,000 annually.
There’s no current tax on investment earnings within the account, though you also don’t get to claim a deduction for losses. Distributions from the account, usually during retirement, are taxed at ordinary income rates. If you change jobs or retire, you normally can choose among keeping the money in your old company’s plan, shifting it to a new 401(k), or rolling over some or all of the account to an IRA.
That’s the short story. But there are numerous other legal limits and restrictions to contend with. One of the biggest is the annual limit on how much salary you can defer, a number that rises based on an inflation index. Furthermore, the plan must satisfy strict, complex nondiscrimination requirements.
How well do you know the current rules? See how you fare on this brief quiz.
1) The maximum amount an employed 45-year-old can contribute to a 401(k) in 2012 is:
2) The maximum amount an employed 55-year-old can contribute to a 401(k) in 2012 is:
3) The maximum amount a retired 65-year-old can contribute to a 401(k) in 2012 is:
4) The minimum number of employees required to establish a 401(k) plan is:
5) If you aren’t a company’s owner, you must begin taking distributions from its 401(k) plan:
a) At age 59½.
b) At age 70½.
c) When you retire.
d) At age 70½ or your retirement date, whichever comes later.
6) A rollover from a 401(k) plan to an IRA is subject to a 20% withholding tax unless:
a) You complete the rollover within 60 days.
b) You arrange a trustee-to-trustee transfer.
c) You retire before the end of the tax year.
d) You are under age 59½.
7) If you receive a $10,000 “hardship distribution” from a 401(k) in 2012 and you’re in the 25% tax bracket, your income tax liability is:
Answers: 1-b; 2-d; 3-a; 4-a; 5-d; 6-b; 7-c