The 401k plan is a type of defined contribution pension
plan available in the United States. Named after a section
of the 1978 Internal Revenue Code, it is a device to provide
tax advantages on money set aside for retirement. Other types
of defined contribution plans include 403(b) plans covering
workers in nonprofit entities and the 457 plan that covers
employees of state and local governments.
401(k) plans must be sponsored by an employer, typically
a corporation. The employer acts as a plan fiduciary and is
responsible for creating and designing the plan as well as
selecting and monitoring plan investments.
The employee asks to have part of his salary paid directly,
or deferred, into the 401(k) fund. In participant-directed
plans the employee can then select from a number of investment
options. In trustee-directed 401(k) plans the employer appoints
trustees who decide how the plan's assets will be invested.
Taxes on contributions to 401(k) plans and the earnings on
those contributions are deferred until the money is withdrawn
from the plan. At the time money is withdrawn from the plan
it is taxed as regular income. Withdrawals are typically made
at or after retirement. In most cases in which employees take
money taken from accounts prior to retirement they must pay
a 10 percent penalty to the IRS.
Theodore Benna, a consultant working for The Johnson Companies,
created the first 401(k) plan in 1980. During the decade of
the 1990s the plan proved popular with workers because it
has more flexibility than Individual Retirement Accounts,
known as IRAs. 401(k) plans have higher yearly contribution
limits than IRAs. Also, 401(k) plans are tax-qualified plans
covered by the Employee Retirement Income Security Act of
1974 (ERISA) which means that assets held by the plans are
protected from creditors. That protection does not apply to
IRA accounts in some states.
Many plans also allow employees to take loans from their
401(k) to be repaid with after-tax funds at a low, predefined
interest rates. The interest proceeds then become part of
the 401(k) balance.
401(k) plans also proved popular with employers looking for
ways to reduce their pension costs. In most cases, defined
contribution plans are less expensive than defined benefit
plans for employers. 401(k) plans also create a predictable
cost for employers while the cost of defined benefit plans
can vary unpredictably from year to year.
At present, there are a number of financial-advice sites
on the Internet that describe these plans in their free-content