Understanding Traditional 401(k) Plans

What is a 401(k) Plan?

It's never too soon to begin saving for retirement. And if you're working, your company 401(k) plan is an easy way to get started.

A 401(k) is an employer-sponsored retirement plan that allows you to set aside part of your salary, before taxes are taken out, to save for your retirement.

Although you'll probably find information at work about how to start saving, we're here to help, too. Here's some information to help you learn more about Traditional 401(k) plans:

Who is eligible?

Many businesses offer 401(k) plans to eligible employees. Typically, an eligible employee is someone over the age of 21, who has been with the company at least one year, and has worked for at least 1,000 hours in that year. A business may make their plan's eligibility rules less restrictive based upon their own demographics and objectives.

How does an employee contribute to the plan?

Once a 401(k) plan is set up, employees can elect to make contributions from their paycheck in one of two ways: before paying federal income taxes or after-tax as a Designated Roth Contribution (if elected by the company). If Designated Roth Contributions are made available in the plan, employees generally pay tax on those contributions when they are made, but don't owe tax on the money when it is withdrawn.

What are contribution limits?

In 2018, the maximum contribution that employees can make is $18,500 with an additional $6,000 if they are age 50 or older. The employer can also make additional contributions for all eligible employees. Any investment earnings within the plan grow tax-deferred until the funds are withdrawn in retirement.

What are employer contributions?

Employers do not have to contribute to the 401(k) plans that they offer, but most do. Some choose to contribute a flat amount of money for all eligible employees, some contribute a percentage of the eligible employees' compensation, and others match the eligible employees' contribution based upon an established formula.

The employer's contributions may vest over time, meaning that the employee may have to stay with the company for several years in order to receive the full amount when withdrawn from the plan.

Withdrawals are usually not allowed until the employee leaves the company. When that happens, the employee can generally roll the funds into a traditional IRA without paying taxes. If the employee decides to withdraw the money and receive the funds directly, then income taxes on the contributions and earnings will generally have to be paid along with a 10 percent penalty tax if the employee is under age 55.

Some employers allow employees to take out loans against the funds in their 401(k) plans and may also allow for withdrawals for hardship circumstances. If you are eligible to participate in your employer's 401(k) plan, consult the Summary Plan Description for details on the plan's provisions and benefits.


Neither State Farm® nor its agents provide tax or legal advice.