A 401(k) is a retirement savings plan employers offer in the United States. It allows employees to contribute a portion of their salary on a pre-tax basis, meaning that the money is taken out of their paycheck before taxes are withheld.
The funds in a 401(k) account are invested in various assets such as stocks, bonds, and mutual funds, and the investment earnings grow tax-free until withdrawn in retirement. Employers may also offer matching contributions to encourage employees to save for retirement.
The name “401(k)” comes from the section of the Internal Revenue Code that governs these types of plans.
401K advantages
- Tax benefits: Contributions to a 401(k) plan are made on a pre-tax basis, which means you don’t pay income tax on the money you contribute until you withdraw it in retirement. This can help reduce your taxable income each year.
- Employer matching: Many employers offer a matching contribution to encourage employees to save for retirement. This means that for every dollar you contribute to your 401(k), your employer will also contribute a certain amount, up to a specific limit.
- Investment options: 401(k) plans offer various investment options, including stocks, bonds, and mutual funds. This allows you to diversify your investments and potentially earn higher returns.
- Automatic savings: Contributions to a 401(k) are usually deducted automatically from your paycheck, making it easier to save consistently over time.
- Portability: If you change jobs, you can usually roll over your 401(k) account balance into a new employer’s plan or an individual retirement account (IRA), which allows you to keep your retirement savings growing tax-free.
- Higher contribution limits: 401(k) plans have higher contribution limits than other retirement accounts, such as traditional IRAs. In 2023, the contribution limit for 401(k) plans is $20,500 for individuals under 50 and $27,000 for those over 50.