History of 401k Accounts

• In 1978 Congress added a new section to the U.S. tax code (Section 401k) authorizing the establishment of tax-deferred retirement accounts funded by employees but offered and administered through employers. The idea was to provide a retirement plan for executives in some companies that were not eligible for the traditional pension retirement plans that were typical at the time. But large companies immediately jumped on the idea of employee retirement accounts instead of pensions because it saved them huge amounts of money. After little more than a decade, 401k accounts had largely replaced pension plans.
  
  

Contributions to 401k Accounts

• There are limits to the amount you can contribute to your 401k account every year. In 2009 the maximum amount an individual could contribute to his or her 401k was $16,500, plus the amount of your employer match, if any.
  
  

Withdrawals from 401k Accounts

• You can make qualified withdrawals from your 401k account when you turn 59 1/2. You will pay taxes on the amount you withdraw from your 401k based on your total income that year. Any early withdrawals not covered under the exceptions are penalized an extra 10 percent and have taxes withheld, so the account holder will generally only receive 70 cents in cash per dollar withdrawn early.
  
  

Required Minimum Distributions (RMDs)

• Assuming you are no longer working for the company where you had the 401k, the Internal Revenue Service requires you to begin making withdrawals, called required minimum distributions, or RMDs, at age 70 1/2. The amount of the RMD depends on how much you have in your account and is based on life expectancy statistics. If at age 70 1/2 you are still working for the company where you have the 401k and are still making contributions, you do not have to begin RMDs until you stop working for the company or stop making contributions to your 401k account.
  
  

Advantages of 401k Accounts

• The major advantage to a 401k account is its tax-deferred status. The funds invested in the account continue to grow over time and are not taxed until withdrawal. Another advantage of 401k accounts is that they are self-directed, meaning the worker can choose his own investments. And unlike pensions, a 401k account is portable--that is the 401k funds can be transferred to follow the individual to a new job and a new 401k.