What is a 401(k) and how does it work?


A 401(k) is a general term used to describe savings plans offered by employers to their employees. 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 encourage saving 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, matching a portion of the money you put into your 401(k) account. The “match” is free money to you!

Participation in a 401(k) plan is available only through your employer. The money stays in your 401(k) account until you retire. When you reach age 59 ½ you can start withdrawing the money or transfer it to an IRA (Individual Retirement Account). You will pay income taxes on any money you take out. If you leave your job, the money is still yours: your 401(k) can be transferred to your new employer’s plan or to an IRA.