What is 401(K) Meaning & Definition

A 401(k) is a retirement savings plan offered by employers in the United States. This employee benefit plan is designed to help employees save for their retirement. It has been named after a section of the U.S. Internal Revenue Code which provides tax advantages, encouraging individuals to contribute a portion of their income to a retirement fund.

What is a 401(k)?

It allows employees to contribute a portion of their paycheck into a designated retirement account, typically on a pre-tax basis. This means the contributions are deducted from the employee’s taxable income, reducing their overall tax liability. Employers often match a percentage of the employee’s contributions, enhancing the benefit.

Types of 401(k) plans

There are several types of 40(k) plans, each with distinct features:
1. Traditional 401: Contributions are made with pre-tax dollars, reducing taxable income. Taxes are paid upon withdrawal during retirement.
2. Roth 401: Contributions are made with after-tax dollars, meaning no immediate tax benefit. However, withdrawals in retirement are tax-free.
3. Safe Harbor: Designed to simplify compliance with IRS nondiscrimination tests, ensuring all employees receive equitable benefits.
4. Solo 401: For self-employed individuals, offering high contribution limits and flexibility in managing retirement savings.
This plan account balance is portable, which means you can take it if you change jobs. However, it is not recommended to cash it out when changing jobs, irrespective of how little the balance is. This is because doing so interrupts the flux of compound returns, and it is indeed challenging to compensate for the lost ground over the years. Rather, consider leaving there if the plan’s rewarding, or roll the account over to your latest employer.