A 401(k) plan is a type of retirement plan that offers the advantage of being funded with pretax money; this means that the contributions made by employees are taken from their paychecks before taxes are deducted. The effect of this practice reduces the employee's overall taxable income, according to CNN Money.
Another big benefit of 401(k) plans is that some employers match the contributions that the employee makes, which helps the account grow faster, notes Practical Money Skills. Moreover, when investing money in this type of plan, the money is diversified into money market funds, stock mutual funds, bonds, company stock and other stable investments. This means that the investor is not risking his entire retirement portfolio on one type of investment, so there is less investment risk.
Specific 401(k) plans offer different benefits and drawbacks, notes CNN Money. For example, the Roth 401(k) plan reverses the traditional tax break that is received on regular IRAs by requiring the account holder to pay tax on the contributions made to the account as they are made. As a tradeoff, however, the contributions made grow in a tax-free environment and can be withdrawn at retirement without the need to pay tax on the withdrawals.