A 401(k) is a type of retirement savings plan in the United States that allows employees to contribute a portion of their pre-tax earnings to a tax-advantaged investment account. The name “401(k)” is derived from the section of the Internal Revenue Code that governs this type of plan.
In a traditional 401(k), the contributions made by the employee are not subject to income tax at the time they are deposited, providing a tax deferral benefit. These contributions, along with any potential employer contributions, can be invested in a variety of financial instruments such as stocks, bonds, and mutual funds.
One significant feature of a 401(k) is that the investment earnings within the account also grow tax-deferred until withdrawals are made during retirement. Withdrawals are typically taxed as ordinary income, and there may be penalties for early withdrawals before the age of 59½, with certain exceptions.
Employers often offer 401(k) plans as part of their employee benefits package, and some employers may also match a portion of the employee’s contributions, enhancing the overall retirement savings potential. Overall, 401(k) plans serve as a crucial tool for individuals to accumulate funds for their retirement years.