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401(k) plan

Contributor(s): Matthew Haughn

A 401(k) plan is a type of tax deferred savings pension account that is set up for employees by employers. These plans are named for the subsection 401(k) of the IRS code they are found under.

The 401(k) plan originated in the 1970s as a result of a direct petition of U.S. Congress by a group of salaried employees from Kodak, the imaging technology company. The group asked Congress allow exemptions on taxes for portions of their salary invested in the stock market. In 1978, the 401(k) was created as a means of easing taxes for investing tax payers. The common current use as a means to create a tax deferred savings for retirement was conceived of by attorney and consultant Ted Benna in 1980. Among the roughly two dozen investment options for 401(k) are both Roth IRAs and traditional index funds.

Under a 401(k), contributions made by an employee are deducted from the employee's pay by the employer and placed in a separate account. Contributions can be matched by the employer. Funds are withdrawn pre-taxation, which means that contributions are not taxed, possibly lowering an investors tax bracket. The plan allows employees to contribute up to $18,500 pre-tax income per year.

Barring exceptions, such as the death of an employer or the permanent and complete disability of the employee, a 10% penalty is typically incurred for withdrawals before the age of 59 and a half, much like with the similar purposed Individual Retirement Accounts (IRA). In most organizations, 401(k) and other retirement plans are managed by a human resources management (HRM) department as part of benefits administration.

This was last updated in December 2018

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