What You Need To Know About 401(k) Plans
One of the most popular types of employer-sponsored retirement plans is the 401(k) plan. HOW DOES A 401(K) PLAN WORK? With a 401(k) plan, you elect either to receive cash payments (wages) from your employer immediately, or defer receipt of a portion of that income to the plan. The amount you defer (called an “elective deferral” or “pretax contribution”) isn’t currently included in your income; it’s made with pretax dollars. Consequently, your federal taxable income (and federal income tax) that year is reduced. And the deferred portion (along with any investment earnings) isn’t taxed to you until you receive payments from the plan. Example: Melissa earns $30,000 annually. She contributes $4,500 of her pay to her employer’s 401(k) plan on a pretax basis. As a result, her taxable income is $25,500. She isn’t taxed on the deferred money ($4,500), or any investment earnings, until she receives a distribution from the plan.
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