401k plans

Definition

401(k) plans are employer-sponsored retirement savings plans that allow employees to save and invest a portion of their paycheck before taxes are taken out. These contributions grow tax-deferred until they are withdrawn during retirement.

5 Must Know Facts For Your Next Test

1. 401(k) contributions reduce taxable income for the year they are made.
2. Employers can match employee contributions up to a certain percentage.
3. Withdrawals before age 59½ typically incur a 10% penalty in addition to regular income tax.
4. There are annual contribution limits set by the IRS, which may change yearly.
5. Participants must start taking required minimum distributions (RMDs) at age 72.

Review Questions

• What is the primary tax benefit of contributing to a 401(k) plan?
• What penalty applies if you withdraw funds from your 401(k) before age 59½?
• When must participants begin taking required minimum distributions from their 401(k)?

Related terms

IRA:

An Individual Retirement Account that offers tax advantages for retirement savings, separate from employer-sponsored plans.

Roth IRA: A type of IRA where contributions are made with after-tax dollars and qualified withdrawals in retirement are tax-free.

Pension Plan: A retirement plan where an employer contributes funds on behalf of employees, who receive fixed payments upon retiring.