401(k) plans

A 401(k) plan is a company-sponsored qualified retirement plan. Contributions and earnings in a 401(k) plan are not subject to federal and most state income taxes until the funds are withdrawn. A 401(k) plan allows you to save money on a pretax basis, and most employers will contribute matching funds to make the plan even more lucrative. Usually you will have the option to decide how much you contribute (up to the maximum allowed by the government) and where you will invest your contributions (from a list of funds provided by your plan sponsor).

Once you are eligible to start participating in your company's 401k plan, you will be given a list of funds in which you can invest. You can invest a maximum of $15,500 in your 401(k) plan in 2007. If you are over the age of 50, there is a catch-up amount you can invest in addition to the maximum for each year, $5000 for 2007.

Your contributions will be deducted from your paycheck before taxes are withheld.

Depending on your tax bracket, this pretax deduction can be like getting a 25 percent rate of return on your investment. You'll eventually have to pay taxes on the money, but you should be in a lower tax bracket when that time comes. These contributions are then invested into the funds you select. Most plans offer stock, bond, and money market funds.

Established in 2002 and less well-known are 401(k) plans called Individual 401(k)'s. Designed for sole proprietors and professionals with no employees (other than a spouse), this retirement plan offers higher contribution limits and options than many other existing individual plans like IRAs.

Matching Funds

If you're lucky enough to work for a company that provides the benefit of a company match, it's like earning free money. Enroll in your employer's 401(k) plan, and then contribute enough to earn your employer's maximum matching 401(k) contribution.

Before your 401(k) plan money earns the first dollar of interest, you've already had a 100 percent growth if your employer matches you dollar-for-dollar. Even if the match is only 50 cents on the dollar, that's still an instant 50 percent growth, guaranteed! You can't get that kind of growth anywhere else.

Each company has a vesting schedule, and it is to your benefit to understand exactly when you will become vested. The vesting schedule outlines how much of the company matching contributions and earnings on those contributions you own at any given time. If you leave the company before you are fully vested, you will lose some of the money your employer has contributed to your plan.

Withdrawing Money from a 401(k)

Currently, the law requires that you begin withdrawing money from your 401(k) plan by the age of 70 ½. You can defer this withdrawal rule if you are still a full time employee with the company sponsoring your 401k.

You may begin withdrawals at age 59½ without any early withdrawal penalty. You are also exempt from this penalty if you are over age 55 and have been let go by your company or if you become totally disabled.

Some plans also allow loans from your 401(k).