401(k) plans are the most common type of qualified plan used in the retirement savings industry today. Like all other types of qualified plans, 401(k) plans are governed by the standards set by the Employees Retirement Income Security Act of 1974. This act created qualified plans as a measure to help employees save money for their retirements. ERISA created 401(k) plans, 403(b) plans (which are almost identical to 401(k) plans, except that they are designed for charitable and nonprofit organizations such as churches), profit-sharing plans, money purchase pension plans, Keogh plans and other types of plans. When ERISA was passed in 1974, most major corporations told the government that they would not implement any of these plans unless the Act stipulated that employers could allow their employees to buy shares of their employer's stock inside the plan. The government yielded to this pressure and thus the advent of employees funding their 401(k) plans with shares of company stock came about. This practice continued unabated until the Enron/Worldcom crash of 2002, where thousands of employees who had their entire 401(k) plans invested in shares of these two companies saw their retirement savings evaporate overnight. This fiasco led to a push for restrictions on the amount of company stock that employees could put in their 401(k)s. The charge was made that plan administrators who allowed this practice were failing in their fiduciary duty to look out for the participants' best interests in their plans. However, there is still one advantage to owning shares of company stock inside a 401(k) plan. When an employee who has company shares in his or her plan retires, he or she can spin off these shares of stock and sell them under a special arrangement known as the Net Unrealized Appreciation Rule (NUA). This provision allows the shares that are sold to receive capital gains treatment instead of being taxed as ordinary income. This is the only exception in the entire tax code to the broad-based rule that all IRA and qualified plan distributions are to be taxed as ordinary income, unless the distribution is coming from a Roth account.
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Net Unrealized Appreciation Rule
Is a 401(k) a Qualified Retirement Plan? FAQs
A 401(k) plan is a retirement plan offered by an employer designed to help employees save for retirement.
401(k) plans are the most common type of qualified plan used in the retirement savings industry today.
Contributions are made from the employee’s paycheck on a pre-tax basis and invested in different investment options within the plan as prescribed by the employer. Earnings grow tax-deferred until funds are withdrawn at retirement or upon other specified events like termination of employment or disability.
A 401(k) plan provides an easy way to save and invest for retirement while potentially reducing current taxable income. In addition, many employers offer matching contributions which further enhances potential returns on investments and provide an incentive to participate in the plan.
Yes, there are annual limits set by the IRS on how much can be contributed to a 401(k). Additionally, withdrawals from the account prior to age 59½ may incur penalties and taxes in certain circumstances. Therefore, it is important to understand the rules and regulations of a 401(k) before making any decisions.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
