A 401(k) is a retirement savings plan sponsored by an employer. 401k of the Internal Revenue Code authorized the use of defined contribution plan that allows for the employee to make pre-tax contributions to a retirement savings plan. It lets workers save and invest a piece of their paycheck before taxes are taken out. These contributions and any earnings from the 401(k) investments are not taxed until they are withdrawn.
- Elective salary deferrals are excluded from the employee’s taxable income (except for designated Roth deferrals).
- Employers can contribute to employees’ accounts.
- Distributions, including earnings, are includible in taxable income at retirement (except for qualified distributions of designated Roth accounts).
Under these plans, also commonly known as defined contribution plans, you can save money toward your retirement on a tax-deferred basis. This mean you don’t pay federal or state income taxes on your savings or their investment earnings until the money is withdrawn at retirement. A defined contribution plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis.
The most common types of employer-sponsored retirement savings plans are called 401(k), 403(b) or 457 plans – so named for the Internal Revenue Service tax codes that govern them – and Thrift Savings Plans. Each has a different target audience:
- 401(k) plans are offered to employees of public or private for-profit companies.
- 403(b) plans are offered to employees of tax-exempt or non-profit organizations, such as public schools, colleges, hospitals, libraries, philanthropic organizations and churches.
- 457 plans are offered to employees of state and local municipal governments (and some local school and state university systems).
- Thrift Savings Plans are offered to federal civilian and uniformed services employees.