What is a 401k plan?

A 401k plan is an employee sponsored retirement plan that allows for participants, to make pre-tax contributions to their plan. 401k plan contributions are normally deducted automatically for each employee, every time the employee gets paid. By pre-tax contribution we mean that the money is taken out of the salary, before the salary is taxed.

The money contributed is then invested in one or more funds that are provided by the plan, always at the employee’s direction. Employers will normally ‘match’ the amount that the employee is paying, but in reality an employer is not bound by law to do so.
Over time, the contributions that are saved up in investments are meant to gradually grow, and the contributor is not liable for tax on this growth.

401k plans do offer other advantages to their participants, such as:

• Any business from corporations to self employed individuals may have a plan.
• The company is eligible to set the requirements upon establishment of the plan.
• Employers have the right to restrict individuals like new employees from being eligible.
• Contributions come from voluntary participant’s salary reduction and may be matched by employer.
• An individual could in 2008, defer up to $15,500 of his salary or 10% of his salary, whichever is the least.
• Participants aged over 50, may do contributions of $5000 as catch up payments.
• Withdrawals from employees aged 59.5 or younger, may be penalized.
• Employers are not obliged to match the employees’ payments.
• You may choose to have an internet plan.
• There are on average 15 investment choices.
• Loans can be taken from the plan, and also hardship withdrawals.
• The employer may receive some tax benefits if he matches his employees’ contributions.
• The plan is subject to unfairness testing.


Reference: http://www.401khelpcenter.com/401k_defined.html