What is a 401K plan?

401K plans are tax-deferred, defined contribution savings plans for employees.

• 401K plans are "tax-deferred" because contributions are taken from your paycheck before taxes. Tax is not payable on the amount of the contribution or on earnings on that amount, but income tax is payable on distributions.
• 401K plans are "defined contribution" plans because you and your employer decide up front how much will be contributed to the plan.

There are limits on the amount that can be invested annually in a 401K plan. It is generally not advisable to stop investing during a down market.

You may be eligible for a federal tax credit if your income is low enough.

Getting Money From A 401K

If your 401K plan allows, you can borrow from your plan. Before borrowing from your 401K account, keep in mind that you are losing tax-deferred earnings on the money you take out. If you leave your job, you may have to repay the loan immediately or owe taxes plus penalties.
 
You may be able to take money out of a 401K in certain circumstances. However, keep in mind that income tax is payable when money is taken out of the plan. A penalty may also be payable if money is taken out before age 59 l/2 except for any reason other than disability. There is no penalty if you have attained the retirement age set forth in your Plan. In general, retirement age cannot be earlier than age 55. Certain minimum distributions must be taken starting at age 70 l/2.

Changing Employers

If you move from your current employer to another employer before reaching age 59 l/2, you will probably be able to take a distribution of your account balance (subject to income taxes and penalties) or rollover your account balance to an IRA or your new employer's Plan. (As long as you are able to work, your health condition should not prevent you from being able to change jobs).
 
Investments

It is not advisable to use a 401K as part of your Emergency+Fund or other contingency account. If you need the money and are under age 59 l/2 and are not considered to be "disabled," the withdrawal will be subjected to a 10% penalty. (Alternatives for obtaining money are described in our article: How To Deal With A Financial Crunch).

It is usually up to you to decide how to invest funds in a 401K plan. It is advisable to think of these funds as part of your overall investment portfolio. In addition to traditional retirement factors to consider, consider the possibility that you will need funds earlier because of your health condition.

On Death 

Assets in a 401K plan pass according to your beneficiary designation upon death. There are rules about the time period over which assets in the account are distributed.

Roth 401(K)

A Roth 401K is a variation of the standard 401K. With a Roth 401K, there is no income tax deduction for money going into the plan, but distributions, including earnings, are not taxed when received.

NOTE: Make a note on your calendar to review your beneficiary designation on your 401(k), other pension accounts and life insurance policies at least once a year to be sure they are up to date.

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