A section 401(k) plan is a retirement plan in which an employee can elect to have his or her employer contribute a portion of his or her wages to the plan on a pre-tax basis. These deferred wages are not subject to income tax withholding at the time of deferral, and they are deductible on your Form 1040 since they were not included in taxable wages on your Form W-2. However, they are included as wages subject to social security, Medicare, and federal unemployment taxes.

The amount that an employee may elect to defer is limited. During 2000 an employee cannot elect to defer more than $10,500 per year ($6,000 per year for SIMPLE plans) for all cash or deferred arrangements in which the employee participates. This yearly limitation is indexed for inflation. All contributions to retirement plans (including deferred compensation plans) are subject to additional limits. Refer to Publication 525, Taxable and Nontaxable Income, for more information about elective deferrals. Employers should refer to Publication 560, Retirement Plans for Small Business, for information about setting up and maintaining retirement plans for employees, including 401(k) plans. Generally, all plans maintained by an employer must be considered, to determine if contribution limits are exceeded.

Distributions from a 401(k) plan may qualify for optional lump-sum distributions or rollovers as long as they meet the respective requirements. For more information, refer to Topic 412, Lump-Sum Distributions, Topic 413, Rollovers from Retirement Plans, and Topic 555, 5- or 10- Year Tax Option for Lump-Sum Distributions.

Many plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Hardship distributions are limited to the amount of the employee's elective deferral only, and do not include any income earned on the deferred amounts. Beginning in 1999, they will no longer be treated as eligible rollover distributions.

Distributions received before age 59½ may be subject to an early distribution penalty of 10% additional tax. Early distributions from a Simple 401(k) plan will be subject to a 25% additional tax if the withdrawal is made within the first two years of participation in the Simple Plan. For more information refer to Publication 575, Pension and Annuity Income and the interactive Tax Trail on Pension and Annuity Income. Publications and forms may be downloaded from this site or ordered by calling 1-800-829-3676.

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