Funding your retirement, with help from your employer.
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In the United States, a 401(k) is a retirement savings program organized by employers but funded primarily by workers through paycheck deductions. Because employees generally do not make withdrawals from the fund until after they have retired, the 401(k) is considered a deferred compensation plan.
Once a company has established a 401(k) plan, employees are offered the option of contributing a portion of their earnings toward the retirement plan. Many employers match a certain percentage of each employeeâs contribution. Most plans offer the option of investing among equity and bond mutual funds, and typically offer target-date funds, in which the portfolioâs risk level adjusts as you approach the target date, generally at or near your retirement age.
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Many employers offer the choice between two types: traditional and Roth.
- Traditional 401(k). The money comes out of your paycheck before taxes. However, youâll be taxed on your withdrawals after you retire. (If you tap your savings before you reach age 59 1/2, you may also have to pay early withdrawal penalties.)
- Roth 401(k). In a Roth plan, you pay taxes on your entire paycheck up front, but savings and investment earnings grow tax free. Withdrawals from Roth 401(k) plans are tax free after age 59 1/2.
Employees can roll funds over from an existing employer-sponsored account to a new account, which is useful for those who are switching jobs or retiring.
The 401(k) plan developed from the 1978 reforms of the Internal Revenue Code meant to encourage savings rates in the U.S. Its name is derived from a part of the codeâsection 401(k)âthat permitted employees to set aside tax-deferred retirement funds.
The first program was implemented in 1981. By the year 2000, more than three-fourths of American workers were participating in 401(k) plans. Many companies came to offer 401(k) plans in addition to, or in place of, traditional company-sponsored pension plans.
The Internal Revenue Service limits the amount that a person may contribute to their 401(k) plan in a given year. For the 2024 tax year, the base limit is $23,000, with an additional catch-up contribution of $7,500 for anyone over age 50.
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This article was most recently revised and updated by The Editors of Encyclopaedia Britannica
