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Simple English definitions for legal terms
401(k) plan
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A quick definition of 401(k) plan:
A 401(k) plan is a type of retirement plan that an employer offers to their employees. It allows employees to save money for retirement and defer taxes until they withdraw the money. The employee can contribute up to a certain amount each year, and the employer may also contribute a certain amount. The money in the 401(k) account can be invested in different options. When the employee reaches a certain age, they can start withdrawing the money without penalty. However, if they withdraw the money before that age, they will have to pay a penalty. There is also a type of 401(k) called a Roth 401(k) which taxes the contributions upfront, but withdrawals are tax-free.
A more thorough explanation:
A 401(k) plan is a type of retirement plan that an employer offers to their employees. It allows employees to save money for retirement while deferring taxes. The name comes from the section 401(k) of the Internal Revenue Code.
Employees can contribute a certain amount of their salary to their 401(k) plan each year, up to a limit set by the IRS. Employers may also contribute to the plan, often matching a portion of the employee's contribution. For example, if an employee contributes $1000 to their 401(k), their employer may contribute an additional $500.
Contributions to a 401(k) plan are tax-free until the employee begins withdrawing the money during retirement. At that point, the withdrawals are taxed as income. If an employee withdraws money from their 401(k) before they reach a certain age, they may have to pay a penalty tax in addition to regular income taxes.
There are also Roth 401(k) plans, which tax contributions before they enter the account but allow tax-free withdrawals during retirement. Employees can contribute to both a traditional 401(k) and a Roth 401(k), but their total contributions cannot exceed the IRS limit.
For example, if an employee earns $50,000 per year and contributes 10% of their salary to their 401(k), they would contribute $5,000 per year. If their employer matches 50% of their contribution, they would receive an additional $2,500 from their employer. The employee's contributions and any earnings on those contributions would not be taxed until they begin withdrawing the money during retirement.