Loading the player...

What is a '401(k) Plan'

A 401(k) plan is a qualified employer-established plan to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings in a 401(k) plan accrue on a tax-deferred basis.

BREAKING DOWN '401(k) Plan'

Caps placed by the plan and/or Internal Revenue Service (IRS) regulations usually limit the percentage of salary deferral contributions. There are also restrictions on how and when employees can withdraw these assets, and penalties may apply if the amount is withdrawn while an employee is under the retirement age as defined by the plan. Plans that allow participants to direct their own investments provide a core group of investment products from which participants may choose. Otherwise, professionals hired by the employer direct and manage the employees' investments.

The 401(k) plan was enacted into law in 1978 and is named after the subsection of the Internal Revenue Code that established it. As of the end of 2015, 401(k) plans accounted for roughly $4.7 trillion of the $24 trillion in total retirement plan assets in the United States. Total 401(k) plan balances have increased by more than 100% from 2008 to 2015.

Popularity of 401(k) Plans

Participation in 401(k) plans continues to grow. More than 50 million workers are active participants in their employers' 401(k) plans, with over half a million different company plans in place. Once criticized for their high fees and limited options, 401(k) plan reform has made several changes benefiting employees.

The average plan offers nearly two dozen different investment options, while fund expenses and management fees have continued to drop. Additional features such as automatic enrollment, increased fee visibility, more low-cost index fund options and catch-up contributions for near-retirees have been added to many plans. Additionally, contribution limits are indexed to inflation, allowing participants to make larger contributions to plans over time.

Traditional and Roth 401(k) Plans

One of the greatest advantages of the 401(k) plan is the tax-advantaged nature of contributions and earnings. The traditional 401(k) plan allows employees to make pre-tax contributions to the plan, but it taxes withdrawals from the account. Established in 2006, the Roth 401(k) offers participants another tax-advantaged option; contributions are made with after-tax dollars, but withdrawals are fully tax-free so long as certain conditions are met. The Roth 401(k) option is available in more than 50% of company 401(k) plans.

RELATED TERMS
  1. Roth 401(k)

    An employer-sponsored investment savings account that is funded ...
  2. Opt-Out Plan

    A type of 401(k) plan that automatically enrolls the employees ...
  3. Designated Roth Account

    An individual retirement plan in which employees can have all ...
  4. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt ...
  5. Tax-Sheltered Annuity

    A type of annuity that allows an employee to make contributions ...
  6. Qualified Retirement Plan

    A plan that meets requirements of the Internal Revenue Code and ...
Related Articles
  1. Retirement

    Introduction To SIMPLE 401(k) Plans

    Learn about the features and benefits of the plan that is a cross between a SIMPLE IRA and a traditional 401(k) plan.
  2. Investing

    Understanding 401(k)s and All Their Benefits

    A quick guide to understanding 401(k) advantages, from tax savings to shelter from creditors.
  3. Retirement

    3 401(k)s With the Lowest Expense Ratios

    Discover how to Identify the fees and expenses associated with 401k investing and how it will affect your bottom line in investing.
  4. Retirement

    The Basics of a 401(k) Retirement Plan

    This plan has become one of the most popular retirement options. Here's why.
  5. Retirement

    How Can You Make the Most of Your 401(k)?

    Make the most of your 401(k) plan by contributing early and taking advantage of employer matches.
  6. Retirement

    Is Your 401(k) Being Mismanaged?

    401(k) plans managed by the wrong people can be hazardous to your future!
  7. Retirement

    3 Reasons Your 401(k) Is Not Enough for Retirement

    Learn the basic structure of a 401(k), and a number of reasons why it may not be substantial enough to secure an individual's living upon retirement.
  8. Financial Advisor

    Top 401(k) Shortcomings: What to Know

    Many 401(k) plans are riddled with flaws that can impede retirement savers in many ways. Here are ten of the most common imperfections.
  9. Financial Advisor

    Who Wants to be a 401(k) Millionaire? (TROW)

    Want to be a 401(k) millionaire? Here are some tips to get you on the right path.
  10. Retirement

    My Employer Doesn't Offer a 401(k). Should I Care?

    Find out what do if your employer doesn't offer a 401(k) retirement savings plan, including alternative investment options and whether to switch jobs.
RELATED FAQS
  1. What are the main differences between a Roth 401(k) and a 401(k)?

    Learn more about financial planning, investment options and decision making between traditional 401(k) and Roth 401(k) accounts, ... Read Answer >>
  2. Do 401k contributions reduce AGI and/or MAGI?

    Discover how contributing to a 401(k) plan can reduce your AGI and/or MAGI. Also learn by how much and how this differs from ... Read Answer >>
  3. How can I start or set up a Roth 401(k)?

    Find out more about what options you have to set up a Roth 401(k). Read Answer >>
Hot Definitions
  1. Marginal Utility

    The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important ...
  2. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
  3. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  4. Acid-Test Ratio

    A stringent indicator that indicates whether a firm has sufficient short-term assets to cover its immediate liabilities. ...
  5. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that ...
  6. Taxes

    An involuntary fee levied on corporations or individuals that is enforced by a level of government in order to finance government ...
Trading Center