What is a 401(k) retirement plan?


Quick Answer

A 401(k) retirement plan is a type of retirement plan that features contributions by an employee, and sometimes, matching contributions from the employer, reports CNN Money. The biggest advantage of the 401(k) is the employer-matched contributions, which is usually around 50 cents on every dollar invested.

Continue Reading

Full Answer

The 401(k) plan has additional benefits to offer, reports CNN Money. The tax break provided by the 401(k) is immediate, since the money that the employee contributes to the plan is taken out of the employee's pay prior to any taxes being assessed on his wages. This reduces the amount of the employee's income that he must pay tax on each year. In addition, the growth of the money in the 401(k) is also tax-deferred. This means that there's no taxes on any dividends, distributions or capital gains made on the plan before retirement.

The downfall of this type of retirement plan is that account holders wishing to pull money from their accounts prior to age 59.5 face a steep penalty plus income tax owed on the money withdrawn, notes CNN Money. This can be the tax due plus a penalty of 10 percent. Also, there may be some limitations with the vesting schedule on the plan; plan holders may need to stay with a company for a particular length of time to receive the employer's contributions.

Learn more about Financial Planning

Related Questions