What is the basic structure of a 401(k) plan?

Written by ShawnTe Pierce

First introduced in 1978, the 401(k) plan has steadily become the retirement investment vehicle of choice. Many job seekers look for employers who offer this retirement plan as a part of their benefits package. While many make use of this investment vehicle, there are several others who wonder: what is the basic structure of a 401(k) plan?

Defining the 401(k) plan

A type of qualified employee retirement plan, a 401(k) is offered by employers to eligible employees who can choose to make either pre-tax or post-tax contributions to the plan. Employers can either match the employee contribution with cash or stock sharing, or provide expert advice for employees to set up and manage individual plans.

What is the basic structure of a 401(k) plan?

The 401(k) plan begins with the contribution. The employee chooses the amount they wish to contribute from their salary into the plan. The employer can make a matching contribution if they wish; however, there is a limit to the amount that can be contributed.

In 2009, an employee may only contribute up to $16,500 from their pay and the employee plus employer match combination can't exceed $49,000 per year. There are provisions for those participants who are age 50 and older, where they may make catch-up contributions up to $5,500 over the limit per year. The employee-employer combination for those people rises to a maximum of $54,000 per year.

Reinvestment is a large part of the basic structure of a 401(k) plan. After the initial contribution is made, the money is invested into a block of mutual funds, stocks, bonds, and any other investment provisions the governing plan permits. Sometimes, the plan may have a large list of investment options available and will allow the employee to choose the investment vehicle.

Criteria for withdrawing 401(k) funds

Funds in the plan can’t be withdrawn at will by the employee. Certain criteria must be met:

1. Retirement, death, disability, or the employee has ceased working for the employer.
2. Employee has reached age 59.5.
3. If the plan permits hardship withdrawals and the employee meets the criteria for an allowable hardship as defined by the plan.
4. If the plan is terminated.

If funds are distributed to the employee early, a tax penalty of 10% of the distribution amount will be assessed at income tax time.

Best practices

Now that you know the basic structure of a 401(k) plan, you should be able to pass that information onto your employees as a part of the investment plan education materials. In fact, a comprehensive breakdown of the plan you offer should be given to every participating employee to make them informed.

To get your company started with a structured 401(k) plan, submit a free BuyerZone request for employee retirement plan price quotes. We’ll match you to multiple providers in your area who will allow you to compare rates and services provided.