What is a 401(k) plan?

A 401(k) plan is a retirement savings program that is specifically sponsored by an employer, allowing employees to contribute a portion of their earnings into the plan. This type of plan offers tax advantages for both the contributions made by employees and the earnings on those contributions. For example, contributions to a traditional 401(k) are typically made pre-tax, meaning they can lower taxable income during the year the contributions are made, while funds grow tax-deferred until they are withdrawn in retirement.

Furthermore, many employers may offer to match a portion of employee contributions, providing an additional incentive for employees to save for retirement. This match is essentially “free money” and helps to increase the employee's retirement savings.

Unlike personal savings accounts, which may not have specific tax advantages or be tied to employment, a 401(k) is inherently designed to support long-term retirement planning. It is also distinct from short-term investment options or government assistance programs, both of which serve different purposes and do not provide the same framework for building retirement funds.