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A member of 401k plan need not to pay income tax on the amount of contributions made towards this plan as this plan is tax-deferred. The amount contributed by an employee towards 410k plan is deducted while calculating his taxable income during that year. According to a survey carried out during year 2004, about $750 savings were made by every single individual by contributing towards 410k plan.
Financial benefits obtained out of 401k plan account investments are tax-deferred till these earnings are withdrawn by the employee. It gives an advantage to the participant of the 410k plan by allowing him to accumulate tax-free compound interest on his contributions and investment earnings over the years.
You have to pay taxes on the plan money only after you withdraw it. Normally, people withdraw it after retirement. Irrespective of the tax bracket to which employee belongs at the time of withdrawal from 401k plan, he is subjected to taxes at ordinary income rates. This criterion is based on the assumption that the individual would be in the lower tax bracket at the time of retirement. However, this assumption may not be true in all cases.
The IRS permits the tax deduction benefit for contributions made towards 401k plan with certain restrictions. To get this tax deferral benefit an employee must keep his assets in his current plan or other tax-deferred plan till he attains age of 59-1/2 years. If an employee affect withdrawal before attaining the laid down age condition, he has to pay 10% penalty tax. However, there are certain exceptions when this 10% penalty tax is not charged. These exceptions are:
- Withdrawals owing to death of the employee
- Withdrawals owing to employee becoming permanently and totally disabled
- Withdrawal due to separation of the employee from service after he has attained age of 55 years or more
- If the withdrawal is for deductible medical expenses
- Payment to spouses, children and dependents when ordered by a court of law under section 72(t) through qualified domestic relations order.
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Category: 401k Plans
Tags: 401k plan, 401K plan investment.
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2 responses so far ↓
1 What is Roth IRA, and it's role in 401K Plan // Jan 30, 2008 at 1:38 pm
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2 Withdrawals and Loans from 401K » Blog Archive » Withdrawals and Loans from 401K // Jul 2, 2008 at 10:29 am
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