The employee elects to have a
portion of his or her wage paid directly, or "deferred", into
his or her 401(k) account. In trustee-directed
401(k) plans, the employer appoints trustees who decide
how the plan's assets will be invested. In
participant-directed plans (the most common option), the
employee can select from a number of investment options,
usually an assortment of mutual funds that emphasize stocks,
bonds, money market investments, or some mix of the above.
Many companies' 401(k) plans also offer the option to
purchase the company's stock. The employee can generally
re-allocate money among these investment choices at any time.
These plans are called "defined contribution" plans, to
distinguish them from "defined benefit" plans such as a
traditional pension. Defined benefit plans have a definitely
determinable benefit amount that usually has a fixed formula,
regardless of how the underlying plan assets perform. Defined
contribution plans according to Section 414(i) of the IRC have
individual accounts. Because plan sponsors want to take
advantage of the exemption from the fiduciary duty to
diversify plan assets to minimize the risk of large losses by
using ERISA Section 404(c), these plans usually provide each
worker the ability to control the contents of his account. The
account value may fluctuate in value based on the underlying
investments. There is a risk that returns may even be
negative.
When an employee leaves a job, the 401(k) account generally
stays active for the rest of his or her life, though the
accounts must begin to be drawn out beginning at age 70-1/2.
In 2004 some companies started charging a fee to ex-employees
who maintained their 401(k) account with that company.
Alternatively, when the employee leaves the company, the
account can be rolled over into an IRA at an independent
financial institution, or if the employee takes a new job at a
company that also has a 401(k) or other eligible retirement
plan, the employee can "roll over" the account into a new
401(k) account hosted by the new employer.
Source: Wikipedia
