Your ability to save for your retirement and defer paying the taxes on that investment money until you retire is the benefit of investing into a 401k account.    Very few other investments allow you that tax deferred benefit.   But since all 401k plans are not designed the same, you need to learn about the basic rules before moving forward with your investment.

All 401k plans do not have the same flexibility and structure.  Below you will learn about 401k plan options, 401k rules and 401k contribution limits.   With this basic knowledge, you can then approach your employer about your own company’s 401k plan design.

Just remember that the 401k plan benefits of tax deferral far outweigh any obstacles in regards to the 401k plan rules.   Learn about the basics so that you can have confidence when you talk with your employer about your retirement account.

Your Guide To 401k Plan Basics:

401k Plan Options:

A 401k plan can be designed to include any or all of the following:

  • Stock mutual funds as an investment choice
  • Bond mutual funds as another investment choice
  • Cash or money market
  • Employer matching
  • Self-directed brokerage, which is individual stock purchases
  • Employer stock
  • Target-date mutual funds
  • Life-style mutual funds
  • Automatic enrollment capabilities
  • Financial educational programs
  • Individual financial planning sessions
  • Participant call centers
  • Internet services

Your employer’s 401k plan administrator should be able to explain in detail which of the above options are built into your company’s 401k plan.

401k Plan Rules:

These rules apply to contributions, withdrawals, loans and rollovers.

401k Contribution Rules:

  • The only way you can contribute to your 401k account is through payroll deductions.
  • The contribution rules also apply to plan limits, see below.

Withdrawal Rules:

  • At age 59 1/2 you can withdraw from your 401k plan without incurring a penalty.  You will have to pay taxes on the amount of your withdrawal.
  • If you make a withdrawal before 59 1/2, you incur a 10% penalty.   You will have to pay taxes on the withdrawal amount.
  • If you become disabled or meet the hardship qualifications, you can withdraw before 59 1/2 without incurring the 10% penalty.    But you will still have to pay taxes on your withdrawal.

Loan Rules:

  • Some 401k plans are designed to allow you to take a loan against your 401k balance.
  • Maximum loan percentage is 50% of your vested account balance.
  • Maximum loan amount cannot exceed $50,000.

Rollover Rules:

  • 401k benefitWhen you leave your employer, you can rollover your balance to your new employers’ 401k plan.
  • You can also rollover your balance to an IRA.
  • You face less risk of paying taxes and a penalty if you have the money transferred as a direct rollover or trustee-to-trustee transfer.  This is where your employer works directly with the “institution” receiving your rollover vs you taking possession of the money and making the transfer yourself.
  • If you take possession of the money with the intent of depositing it into your new employer’s 401k plan or an IRA, you have 60 days to make that deposit or you pay taxes on the amount plus a 10% penalty if under the age of 59 1/2.
  • If you take possession of the money, your employer is required by law to withhold 20% right off the top for taxes.

401k Contribution Limits:

  • For 2009 the 401k contribution limits are $16,500.   If you are over the age of 50, the 401k plan limits include a catch-up contribution amount of an additional $5,500.
  • For 2010, the 401k contribution limits remained the same as 2010.
  • The 401k contribution limits for 2011 will remain the same as 2009 and 2010. (see above)

The 401k contribution limits are adjusted by the Department of Labor and the IRS to keep up with inflation.   These limits generally change every year, but sometimes they remain the same as the previous year.   To be on the safe side, double-check with your tax accountant every year on the new 401k contribution limits.

401k plan rules can be complicated so we attempted to simplify the rules, limits and plan options for you.    By learning your basics you will be confident when talking with your own company’s 401k plan administrator.