A section 401(k) plan is a retirement plan in which an employees can elect have their employer contribute a portion of their wages before taxes each year. These deferred wages are not subject to income tax withholding at the time of deferral, nor are they 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 1999 an employee cannot elect to defer more than $10,000 per year for all cash or deferred arrangements in which the employee participates. This yearly limitation duplicates the 1998 limitation. The amount is indexed for inflation and generally cannot exceed the lesser of 25 percent of compensation or $30,000 when added to other employer contributions for the participant. Generally, all plans maintained by an employer must be considered, to determine if contribution limits are exceeded. The employer may specify a lower maximum deferral percentage in the plan.

Distributions from a 401(k) plan 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.

Distributions received before age 59 may be subject to an early distribution penalty of 10%.

For more information, select Topic 427, or get Publication 575, 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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