Definition
A 401(k) is an employer-sponsored retirement plan that lets employees defer income into investments on a pre-tax or Roth basis.
How It Works
Employees contribute through payroll up to an annual limit, often with an employer match. Pre-tax contributions reduce current taxable income and grow tax-deferred, while Roth contributions grow tax-free. An additional catch-up contribution is allowed at older ages.
Example
An employee defers the annual maximum into a 401(k), reducing current taxable income and capturing the employer match.
Who It Applies To
Employees whose employers offer a plan.
Watch-Outs
The standard deferral limit is modest relative to a high earner's income, which is why some pursue the mega backdoor Roth or pair the 401(k) with a cash balance plan for larger contributions.
