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What is a 401(k) Retirement Plan?
With a 401(k) plan, employees can choose to defer some of their salary.  So instead of receiving that amount in their paycheck, the employee defers, or delays, getting that money.  In this case, their deferred money is going into a 401(k) plan sponsored by their employer.  This deferred money generally does not get taxed by the federal government or by most state governments until it is distributed.
 
If you establish a 401(k) plan, you:
  • Can have other retirement plans.
  • Can be a business of any size.
  • Need to annually file a Form 5500.
 
You can make a 401(k) plan as simple or as complex as you want to.  A pre-approved 401(k) plan might be just the thing if you want to cut down on administrative headaches and expenses.
 
Pros and Cons :
  • Greater flexibility in contributions.
  • Employees may contribute more to this plan than under IRA plans.
  • Good plan if cash flow is an issue.
  • Optional participant loans and hardship withdrawals add flexibility for employees.
  • Administrative costs may be higher than under more basic arrangements.
  • Need to test that benefits do not discriminate in favor of the highly compensated employees. This testing can be complicated.
  • Additional withdrawal and loan flexibility adds administrative burden for the employer.
 
Who Contributes :  Employee salary deferrals and/or Employer contributions.  Employees are always 100% vested in their salary deferrals.  Employer contributions may be vested on a graduated vesting schedule.
 
Contribution Limits :
Employee - $14,000 in 2005, $15,000 in 2006.  If the employee is aged 50 and over, an additional “catch-up” contribution is allowed.  The additional contribution amount is:  2005 - $4,000 and 2006 - $5,000.
 
Employer/Employee – The lesser of 25% of compensation or $42,000 in 2005 ($44,000 in 2006).
 
Filing Requirements :  Annual filing of Form 5500 is required.
 
Participant Loans :  Permitted.
 
In-Service Withdrawals :  Yes, but subject to possible 10% additional tax if under age 59-1/2.
 
NOTE: The above information was provided from the www.irs.gov website.