Business

What is a 401(k) Plan

A 401(k) plan is a retirement savings plan offered by many American employers
that has tax advantages for the saver. It is named after a section of the U.S. Internal
Revenue Code (IRC).

The employee who signs up for a 401(k) agrees to have a percentage of each
paycheck paid directly into an investment account. The employer may match part
or all of that contribution. The employee gets to choose among a number of
investment options, usually mutual funds.

KEY TAKEAWAYS

• A 401(k) plan is a company-sponsored retirement account to which employees can contribute income, while employers may match contributions.
• There are two basic types of 401(k)s—traditional and Roth—which differ primarily in how they’re taxed.
• With a traditional 401(k), employee contributions are pre-tax, meaning they reduce taxable income, but withdrawals are taxed.
• Employee contributions to Roth 401(k)s are made with after-tax income: There’s no tax deduction in the contribution year, but withdrawals are tax-free.
• Employer contributions can be made to both traditional and Roth 401(k) plans.