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How 401 k Plans Work

Borrowing From Your Account

You may be thinking that you really can't afford to put 15 percent of your salary into an account you won't be able to touch until you retire. But in some 401(k) plans, you can borrow from your account in the event of an emergency. You'll pay interest, but you are paying it to yourself. (There can be some disadvantages that go along with the advantages of taking out a loan against your 401(k).)

And finally, if you're thinking about just opening an IRA (which is still a smart thing to do), you might take note that you can only contribute $4,000 annually to an IRA (in 2006 -- this will increase to $5,000 by 2008), while your annual contribution to the 401(k) can be up to $11,000.

Changing jobs

What if you change jobs? Does that mean you have to pay the tax and penalty in order to keep your money? No. You can either:

  • Keep your money in your former employer's plan
  • Roll the money over into a new 401(k) plan or IRA You do have the option of cashing out, but unless you are 59.5 you will have to pay the tax and the 10-percent penalty to the IRS.

If you decide to roll it over into another 401(k) or IRA, MAKE SURE you don't let the check be written to you. The check has to be written to go directly into the new account. There is no grace period for putting the money into the new account. If it does come to you rather than the new account, you'll be charged the tax and the 10-percent fine.

If you choose to keep your money in your former employer's plan, then there are also a couple of requirements. First, you have to have a fully vested total of at least $5,000 in your account, and second, you have to be under the plan's normal retirement age (usually 65).