401(k)

Also called 401k, traditional 401(k)

An employer-sponsored retirement plan that lets workers save part of each paycheck, usually before income tax, with investments growing tax-deferred.

What it means

A 401(k) is a workplace retirement plan offered by many private-sector employers. Employees choose a percentage of pay to contribute, and the money goes straight from each paycheck into an account invested in a menu of funds the plan selects.

In a traditional 401(k), contributions are made before federal income tax, which lowers taxable income today. The account grows without yearly tax, and withdrawals in retirement are taxed as ordinary income. Many plans also offer a Roth option and an employer match. The IRS sets a contribution limit each year, with an extra catch-up amount for workers age 50 and older.

Example

Suppose someone earning $60,000 contributes 6% of pay, or $3,600 a year. If their hypothetical marginal tax rate is 22%, the pre-tax contribution trims about $792 from that year’s federal income tax, and the full $3,600 is invested.

How it’s used

Saving for retirement automatically through payroll
Capturing an employer match
Lowering current taxable income

Strengths and weaknesses

Strengths

Automatic payroll deductions make saving consistent
Pre-tax contributions reduce current income tax
Employer matching can add free money
Higher annual limit than an IRA

Weaknesses

Investment choices are limited to the plan’s menu
Fees vary widely from plan to plan
Most withdrawals before 59½ face a 10% additional tax
Withdrawals in retirement are taxed as ordinary income

Good to know

Check the plan’s fund expense ratios; small fee differences compound over decades.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.