In the United States, an individual 401k is an account that serves the purpose of retirement savings for individuals or workers. This account was named after the title 26 of the United States Code’s Internal Revenue Code. Each person working in the United States is subject to contribution plans whose annual amount is limited to about $17000. When making contributions to an individual 401k account, a worker does not have to pay any taxes as the amounts are directly deducted from their actual wages. However, taxes apply whenever the employee decides to go withdraw money from the individual and roth 401k account.
The individual 401k incurs tax ramifications for their contributor. Indeed employees may have the option to contribute to their plan either on a pre-tax or post-tax basis. On a pre-tax basis, the worker pays federal income taxes on the amount that they decide to transfer as a contribution to the individual 401k account, while on a post-tax basis, these taxes are effective every time a withdrawal is made from the 401k account. In the 2006 tax year, the Roth 401k deduction was introduced and made available to all American employees. The Roth 401k is another retirement savings plan comparable to the individual 401k plan; it was authorized by the American Congress and is relatively complementary to the 401k plan, at least in terms of features. Through the Roth 401k deduction, a worker may choose to be taxed whenever they withdraw money, to have the tax deferral on all the earnings of the account, and may request that these earnings be tax free if they qualify for a certain distribution.
Can You Withdraw Funds Early?
Early withdrawals of funds on individual or Roth 401k plans based on pre-tax contributions are harshly punished by employers, especially when the individual is still an active employee of the firm and under the age of 59.5. Whenever an individual presents these two features but goes ahead and withdraws cash from their 401k account, an excise tax immediately applies. The excise tax is a duty tax that essentially applies on the sale and production of goods in a country. This tax has also been invented to target and discourage the development of professions and activities deemed to bear immoral characteristics such as the use of narcotics, gambling or prostitution. One may now see better why employers will give a hard time on all still actively-employed workers in their company who attempt to withdraw their money prior to being at least 59.5 years old.
401k plans are subject to deferral limits. As outlined in the first paragraph, each worker may contribute to their 401k account to up to 17000 dollars yearly. This limit tends to go up year after year as it was 15000 dollars for the year 2008 and 16500 dollars for years 2009, 2010 and 2011. It may happen that a worker makes contributions for more than what they are entitled to for a given year. Thus if an individual’s contributions on a pre-tax or Roth 401k plans are higher than the legal maximum, the excess and any associated earnings must be withdrawn or corrected by April 15 of the next year. Most of the time the people that experience this type of situations are those who switch jobs during the same tax year. By failing to regulate the contribution limits of the new worker on their behalf, the new employer may cause the new hire to be forced to pay taxes on the excess contribution amount. This extreme scenario generally occurs when the violation of the contribution limit has been detected too late. Because of this risk, employees are strongly advised to keep an eye on their 401k annual contributions as they would not be able to blame their employer in case a violation is noticed.