What is a 401(k) plan? Here are the basics of what you need to know.

The term 401(k) has become part of our everyday vocabulary, and a big part of the conversation whenever we talk about retirement. You might have a 401(k) plan, but how much do you really know about it? Do you know where your money goes and how it all works? And why is it called a 401(k), anyway?

Let's start with the very basics. A 401(k) is a general term used to describe savings plans offered by employers to their employees. The name 401(k) comes from the section of the IRS code that established this type of savings plan in 1978. Depending on what kind of employer you work for, your plan might technically be called a 403(b) or 457 plan.*

The purpose of a 401(k) plan is to help you save for retirement by:

1.

Automatically transferring money from your paychecks into your 401(k) account – you decide how much (up to certain annual limits).

2.

Not taxing the money that goes into your 401(k) account, and allowing the money to grow tax-free. You don't pay taxes until you withdraw the money.

3.

Employers, in many cases, match a portion of the money you put into your 401(k) account. This “match” is essentially free money. *

* 403(b)s are for employees of public schools and most other nonprofit organizations. 457s are for employees of state and local governments and qualified nonprofits. Thrift Savings Plans (TSPs) are for federal employees. All of these plans work in much the same way as 401(k)s, though there are important differences.

Related