401k plans
Definition
401(k) plans are employer-sponsored retirement savings plans that allow employees to save and invest a portion of their paycheck before taxes are taken out. These contributions grow tax-deferred until they are withdrawn during retirement.
5 Must Know Facts For Your Next Test
- 401(k) contributions reduce taxable income for the year they are made.
- Employers can match employee contributions up to a certain percentage.
- Withdrawals before age 59½ typically incur a 10% penalty in addition to regular income tax.
- There are annual contribution limits set by the IRS, which may change yearly.
- Participants must start taking required minimum distributions (RMDs) at age 72.
Review Questions
- What is the primary tax benefit of contributing to a 401(k) plan?
- What penalty applies if you withdraw funds from your 401(k) before age 59½?
- When must participants begin taking required minimum distributions from their 401(k)?
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Related terms
IRA: An Individual Retirement Account that offers tax advantages for retirement savings, separate from employer-sponsored plans.
Roth IRA: A type of IRA where contributions are made with after-tax dollars and qualified withdrawals in retirement are tax-free.
Pension Plan: A retirement plan where an employer contributes funds on behalf of employees, who receive fixed payments upon retiring.
