How Does a 401(k) Plan Work?


A 401(k) is an employer-sponsored plan for retirement investing and savings in which contributions are matched by the company up to a set limit, as stated by the Wall Street Journal. The plan may include a variety of investments, and money is deducted prior to taxation.

The 401(k) plan allows the employee to choose where to invest retirement savings, with most options including a variety of bonds, stocks and investments in the money market, according to the Wall Street Journal. The plan is named after its governing tax code, and it has replaced pension funds in most settings as a lower-cost alternative for the employer. Employees generally need to work for the employer for a minimum time period before gaining access to the funds. Hefty penalties await for those who withdraw funds before reaching retirement age.

An administrator is hired to keep track of 401(k) accounts, and employees can oversee and manage their investments during their employment, as confirmed by the Wall Street Journal. Even if the employer goes under before the employee gains access to the funds, all investments remain intact. Although employees can choose how much of their salary to invest, the employer often matches contributions of up to 3 percent of the salary.