What Is a 401(k)?

A 401(k) is a type of employer-sponsored retirement account that allows employees to save and invest for the future through automatic contributions from their paycheck.

A traditional 401(k) is typically funded with pre-tax dollars. This means contributions are taken from your paycheck before income taxes are calculated. Because less of your income is taxed in the current year, your take-home pay is reduced by slightly less than the amount contributed.

Money in a traditional 401(k) grows tax-deferred, meaning taxes are not paid on contributions or investment growth until funds are withdrawn later, usually during retirement.

Most employees are eligible to contribute to a 401(k), although some employers may require a short waiting period after being hired. Like other retirement accounts, 401(k)s have rules, including annual contribution limits and guidelines regarding when withdrawals can be made without penalties.

Many employers offer a matching contribution, meaning they contribute additional money to the account based on how much the employee contributes. Matching programs vary by employer, but this benefit can significantly increase retirement savings over time. Contributing at least enough to receive the full employer match is often considered an important opportunity, since the match represents additional compensation provided by the employer.

In addition to the traditional 401(k), many employers now offer a Roth 401(k) option. Roth 401(k) contributions are made with money that has already been taxed. As with a Roth IRA, qualified withdrawals in retirement can include both contributions and earnings without additional taxes.

Both traditional and Roth 401(k)s come with their own rules and considerations, and the choice between them often depends on individual circumstances and preferences. Some people choose one, while others use a combination when available.

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