What Is a 401(k) Plan?

What Is a 401(k) Plan?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A 401(k) plan is a retirement savings account that you can contribute to through automatic payroll withholding. Known as a type of ‘defined contribution’ plan, a part of your salary, decided by you, is put into this account before taxes are taken out. This usually lowers your overall taxable income. In many cases, employers match contributions up to a certain percentage, essentially free money towards your retirement. Contributions and earnings within the 401(k) are tax-deferred until you start withdrawing the funds in retirement.

Related Questions

1. What happens when I retire?

When you retire and start withdrawing from your 401(k) plan, you’ll need to pay taxes on the withdrawals since these funds were originally put into your account pre-tax. The amount you withdraw will be added to your income for that year and taxed accordingly.

2. Can I access my 401(k) funds before retirement?

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In certain cases, you can access your 401(k) funds before retirement age but it’s generally not recommended. Early withdrawal often results in penalties and taxes that can significantly reduce your savings. There are exceptions for specific situations, such as hardship withdrawals or loans against your 401(k).

3. How much can I contribute to a 401(k)?

The contribution limits to a 401(k) are adjusted annually. For 2022, you can contribute up to $20,500 if you’re under 50. If you’re age 50 or older, you can make an additional “catch-up” contribution of $6,500, making your total allowable contribution $27,000.

4. What’s the difference between a Traditional 401(k) and a Roth 401(k)?

Traditional 401(k) plans offer immediate tax benefits, but you’ll have to pay taxes when you withdraw retirement funds. Roth 401(k) contributions are made with after-tax dollars. This means you won’t get a tax break when you deposit money, but you’ll not have to pay taxes upon qualified withdrawals.

5. What happens to my 401(k) if I change jobs?

If you change jobs, you can choose to “rollover” your 401(k) to your new employer’s plan if one is available. You could also roll it into an Individual Retirement Account (IRA). Alternatively, you can leave the money in your old employer’s 401(k) plan or finally withdraw the funds entirely, which may result in penalties if done before retirement age.