A 401(k) is a feature of a workplace retirement plan (a qualified profit-sharing plan) that lets employees contribute part of their wages into an individual account set up in the plan.
What makes a 401(k) powerful is the combination of tax advantages, potential employer contributions, and long-term investing inside the account.
The three core features of a 401(k)
1) You can contribute directly from your paycheck
Most contributions are made as elective salary deferrals—money you choose to send from your wages into your 401(k) account.
2) You may get employer contributions
Employers can contribute to employees’ 401(k) accounts (often in the form of a match, but employer contributions can take other forms depending on the plan).
3) Taxes depend on whether it’s “traditional” or “Roth”
A 401(k) can include different tax treatments:
- Traditional (pre-tax) deferrals: These elective deferrals are generally excluded from your taxable income when contributed.
- Designated Roth deferrals: Roth contributions are the exception—these are not excluded from taxable income up front.
Later, when you take money out:
- Distributions (including earnings) are generally included in taxable income at retirement—except for qualified distributions from designated Roth accounts.
Participating smartly: the practical checklist
Know the contribution limits
401(k) plans have annual contribution limits that can change over time, so it’s important to review the current limit for the year you’re contributing.
Understand your plan’s options and rules
Workplace plans differ. Your plan may include features like automatic enrollment, Roth accounts, and other design choices that affect how contributions work.
Think ahead about taxes
- If you prefer a potential tax break now, traditional deferrals may be appealing.
- If you want the possibility of qualified Roth distributions later, designated Roth deferrals may be appealing.
(Which is “better” depends on your situation, tax bracket now vs. later, and your long-term plan.)
Choosing and setting up a 401(k) plan (for employers)
Plans can vary in type, and there are specific steps involved in establishing a plan. Some also use automatic enrollment features, and plans can offer designated Roth accounts.
Bottom line
A 401(k) is a workplace retirement plan feature that:
- lets you contribute part of your wages to an individual account
- may reduce taxable income for traditional deferrals (Roth deferrals are the exception)
- can include employer contributions
- is generally taxable on withdrawal (except qualified Roth distributions)