401(k) - Financial definition
Country
: United States of America
Concise definition of the term 401(k)
A 401(k) is a retirement savings plan sponsored by employers in the United States, allowing employees to save and invest a portion of their paycheck before taxes are taken out. Contributions to a 401(k) can grow tax-deferred until withdrawal during retirement.
Comprehensive definition of the term 401(k)
The 401(k) plan, named after a section of the U.S. Internal Revenue Code, was established in 1978 to provide a tax-advantaged way for employees to save for retirement. Employers often match a percentage of the employee's contributions, enhancing the growth of the retirement fund. Investment options within a 401(k) typically include a variety of mutual funds, stocks, bonds, and other securities, allowing participants to tailor their investment strategy based on their risk tolerance and retirement goals.
Employees can choose between traditional 401(k) plans, where contributions are made pre-tax and taxed upon withdrawal, and Roth 401(k) plans, where contributions are made with after-tax dollars but withdrawals are tax-free. The 401(k) plan has become a cornerstone of retirement planning in the U.S., particularly as traditional pension plans have declined. However, it requires individuals to be proactive in managing their investments and understanding the rules regarding contributions, withdrawals, and potential penalties for early withdrawal before age 59½.