How Does a 401(k) Work?


Quick Answer

A 401(k) is an employer-sponsored retirement plan that allows employees to put tax-deferred dollars into investment accounts to save for retirement, according to 401khelpcenter.com. Your employer may make optional contributions into your retirement account. There are limits to how much you can contribute to these type of accounts.

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Full Answer

As 401(k) accounts are retirement accounts and not savings accounts, they sometimes have heavy penalties associated with taking premature distributions before the retirement age of 59.5. The investment options are varied, and you have options of stocks, bonds, and mutual funds. Each employee can contribute a maximum of $18,000 into a 401k each year or 100 percent of wages, whichever is less, notes 401khelpcenter.com.

The employer has full responsibility of running the plan in accordance with laws and regulations and decide what kind of investment options are available, if an employee is eligible, and which type of vendors to use for the plan, states 401khelpcenter.com. The employee decides whether it would like to be involved in a 401k retirement plan and how much it contributes.

The 401(k) uses before-tax dollars, which allows you to save more for retirement now. You are only taxed on this money once you take it out, notes 401khelpcenter.com.

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