401(k) Plan Definition
A 401(k) plan is a tax-advantaged, defined-contribution retirement account offered by many employers to their employees. It is named after a section of the U.S. Internal Revenue Code. Workers can make contributions to their 401(k) accounts through automatic payroll withholding, and their employers can match some or all of those contributions. The investment earnings in a 401(k) plan are not taxed until the employee withdraws that money, typically after retirement.
401(k) Plan Key Points
- It is a retirement savings plan sponsored by an employer.
- Allows workers to save and invest a piece of their paycheck before taxes are taken out.
- Taxes aren’t paid until the money is withdrawn from the account.
- Employers often match the employee contributions to some extent, increasing the employee’s savings.
- Early withdrawal (before the age of 59.5) can result in penalties.
What is a 401(k) Plan?
A 401(k) plan is a retirement savings account that allows an employee to divert a portion of their salary into long-term investments. The employer may match the employee’s contribution up to a limit. The main advantage of the 401(k) plan is that the contributions are tax-deductible on the employee’s tax return for the year they are made.
Why is a 401(k) Plan important?
A 401(k) plan is an important tool for saving for retirement. It allows employees to save a portion of their salary and grow their savings tax-free until retirement. The employer match is also a significant benefit, as it is essentially free money added to the employee’s retirement savings.
Who can contribute to a 401(k) Plan?
Any employee of a company that offers a 401(k) plan can contribute. There are, however, limits to how much an employee can contribute each year. In 2021, the limit is $19,500 for those under the age of 50 and $26,000 for those 50 and older.
When can you withdraw from a 401(k) Plan?
You can begin withdrawing from your 401(k) plan without penalty at age 59.5. If you withdraw before this age, you may be subject to a 10% early withdrawal penalty in addition to regular income tax.
How does a 401(k) Plan work?
A 401(k) plan works by allowing employees to contribute a portion of their pre-tax salary to the plan. This reduces the employee’s taxable income for the year, and the investments grow tax-free until retirement. When the employee retires and begins withdrawing from the 401(k), they pay income tax on the withdrawals.
