401(k) Plans

The 401(k) plan is the most widely used type of employer-sponsored retirement plan. All organizations except governmental entities are eligible to set up 401(k) plans. Individual participants can elect to defer income up to $16,500 (for the year 2009) or 100% of compensation, whichever is less. Catch-up contributions of $5,500 (for the year 2009) are allowed in addition to the maximum contribution for individuals who attain age 50 before the end of the taxable year. The amount deferred (called an "elective deferral") is not includable in the employee's taxable income; it is made with pretax dollars. Pretax contributions and any investment earnings are not taxed until withdrawn or distributed, usually at retirement.

To encourage employee participation, some employers offer to "match" employee contributions under a specific formula. Employer contributions to the plan are always made on a pretax basis.

In 2009, annual additions to an employee's plan account (or accounts, if the employer offers more than one type of defined contribution plan) cannot be more than the lesser of 100 percent of that employee's compensation or $49,000 ($46,000 in 2008). Annual additions include both employer contributions and employee contributions. Starting in 2006, an employer can allow an employee to make after-tax "Roth" contributions to the employer's 401(k) plan. Qualified distributions of these contributions and related earnings will be tax free.