401(K)
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An employer-sponsored defined contribution retirement plan that employees can contribute to and employers may also make matching contributions. 401-K contributions are taxed when withdrawn.
Summary
A 401(k) is a workplace retirement savings account that allows employees to automatically save money from their paychecks before taxes are taken out. Think of it as a special savings account where your employer helps you save for retirement - many employers will even match some of your contributions (free money!). The money grows tax-free while it's in the account, but you'll pay taxes when you withdraw it in retirement. It's called a 'defined contribution' plan because you decide how much to contribute, unlike older pension plans where the employer promised a specific payout.
Usage Context
Essential for understanding retirement planning, employee benefits, tax-advantaged investing, and personal financial planning strategies. Critical when discussing long-term wealth building and comparing different retirement savings vehicles.
Common Confusions
- Thinking you can withdraw money anytime without penalties (10% penalty before age 59½)
- Confusing 401(k) with pension plans - 401(k) puts investment risk on employee
- Not understanding that contributions reduce current taxable income but are taxed in retirement
- Assuming all employer matches vest immediately (some have waiting periods)
- Mixing up traditional 401(k) vs Roth 401(k) tax treatment
