The recent economic downturn is taking its toll. Case in point: Some employees are having second thoughts about the viability of their 401(k) plans. According to a recent report by an independent consulting firm, 4% of plan participants stopped making 401(k) contributions at the end of last year. Also, the percentage of 401(k) savings traded jumped to 5.3% in 2008 from 3.5% in 2007.

Nevertheless, despite the understandable concerns of employees in this uncertain economy, the fundamental principle behind 401(k) plans remains sound. Over time, this type of plan can provide a solid base for retirement savings.

Basic premise: In the typical 401(k) plan setup, an employer allows participating employees to defer part of their salary to their accounts on a pretax basis. Each employee determines the amount that he or she chooses to contribute each year, within certain inflation-adjusted limits. The maximum dollar amount allowed for 2009 is $16,500. Then the funds are invested on behalf of the employees according to their investment choices.

Although the employer is not legally required to provide additional funds, it may choose to do so in a matching plan. For instance, an employer may match contributions up to a stated percentage of deferral. With this add-on, employees are often able to set aside a sizeable amount for retirement. Of course, there are no guarantees as to investment earnings, but the contributions may accumulate on a tax-deferred basis over a lengthy period of time.

Furthermore, "catch-up contributions" are permitted for employees who are 50 years of age or older. For example, in 2009 you can add another $5,500 to the pot if you qualify. The total dollar limit for 50-or-older participants is $22,000.

Note that a 401(k) plan must benefit employees in general. It may be disqualified if highly compensated employees contribute a disproportionately higher amount than lower-paid employees. Withdrawals from the plan can be made when an employee separates from service after age 55 or due to death or disability. Otherwise, withdrawals before age 59½ are generally subject to a 10% tax penalty plus regular income tax.

• An employer may institute an automatic enrollment program to ensure that the company meets certain participation requirements under the law.
• Solo 401(k) plans for small businesses have multiplied as administrative costs have been reduced.
• Safe harbor plans have been designed to reduce the strict compliance burdens facing employers. These plans allow you to bypass complex testing procedures and permit highly compensated employees to maximize their contributions.
• A Roth IRA feature can be added to an existing plan, enabling 401(k) plan participants to receive qualified distributions free of any income tax. This new feature first became available in 2006.

Reminder: There are no guarantees about investment earnings within a 401(k) plan. But reliance on sound financial concepts may put you in position to meet your retirement goals.