What is a 401(k) Retirement Account?

If you work for a relatively large company, it's likely that your employer sponsors a 401(k) plan. If so, it's generally a good idea to choose to participate in the program. A 401(k) plan is an employer-sponsored retirement plan that enables employees to take advantage of tax benefits while planning for their retirement years.

Employees are allowed to contribute pre-tax dollars to the plan, reducing their current tax liability because it is deferred to the post-retirement years. Many employers match employee contributions to their 401(k) accounts up to a pre-set limit. This means, that your employer might put "x" amount of dollars into your retirement account for every so many dollars that you invest, up to a cap.

There are typically a number of different investment options available under any given 401(k) plan, allowing individuals to choose their own  investment strategy. There are typically options ranging from very low risk to very high risk investments.

These retirement savings options are referred to as deferred compensation programs, meaning that employees are putting money they earn today into the program for future use. Taxes are paid on the money that employees and their employers contribute once the funds are withdrawn. This reduces current taxable income, thereby reducing the amount of income tax withheld and owed each pay period.

Once an individual reaches retirement age, he or she is required to begin withdrawing money from the account, at which time income taxes and taxes on earned gains become due. Individuals who withdraw funds from the account prior to reaching retirement age are subject to penalties for early withdrawal.

The regulations governing the tax benefits and contribution restrictions impacting 401(k) plans are established and administered under the tax code of the United States government, and protected under ERISA laws and regulations.

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