when workers sign up for a 401 k they agree to deposit a percentage of each paycheck directly into an investment account employers often match part or all of that contribution and employees can choose from a variety of investment options typically mutual funds 11
history of the 401 k the u s has undergone a significant shift in how americans save for retirement as illustrated below by our chart comparing the number of americans in millions in defined benefit and defined contribution plans along with the total for both defined contribution plans most of which are 401 k s are an alternative to the traditional pension known as a defined benefit plan with a pension the employer is committed to providing a specific amount of money to the employee for life during retirement 12 in recent decades as the chart below shows defined contribution plans like 401 k s have become far more common and traditional pensions have become rare as employers have shifted the responsibility and risk of saving for retirement to employees 1314direct contribution plans like 401 k s allow employees to put part of their salary into individual accounts often with matching funds from their employer their ultimate retirement benefits depend on the account s investment performance investopediaabove the number of americans in defined benefit and defined contribution plans along with the total of both in millions 15initially offered by employers to supplement other employee benefits 401 k s have become the most common private employer sponsored retirement program in the u s about a third of working age americans have a 401 k compared with one in nine who have a defined benefit pension plan 10 meanwhile u s census data suggests that as many as four in 10 baby boomers aged 55 to 64 and half of millennials aged 24 to 39 have no retirement account at all 10still the 401 k plan was designed to encourage americans to save for retirement among its benefits are tax savings there are two main options traditional and roth each with distinct tax advantages traditional 401 k with a traditional 401 k employee contributions are deducted from gross income this means the money comes from your paycheck before income taxes have been deducted as a result your taxable income is reduced by the total contributions for the year and can be reported as a tax deduction for that tax year no taxes are due on the money contributed or the investment earnings until you withdraw the money usually in retirement 16roth 401 k with a roth 401 k contributions are deducted from your after tax income this means you contribute from your pay after income taxes have been deducted as a result there is no tax deduction in the year of the contribution when you withdraw the money during retirement though you don t have to pay any additional taxes on your contribution or on the investment earnings even though contributions to a roth 401 k are made with after tax money there are generally speaking tax consequences if withdrawals are made before you re 59 always check with an accountant or qualified financial advisor before withdrawing money from either a roth or traditional 401 k however not all employers offer a roth account option if one is available you can choose between a traditional and roth 401 k you can also contribute to both up to the annual contribution limit 17order your copy of investopedia s what to do with 10 000 magazine for more wealth building advice 401k plan contributions explainedtraditional and roth 401 k plans are defined contribution plans both the employee and employer can contribute to the account up to the dollar limits set by the internal revenue service irs 16 employees contributions to a traditional 401 k plan are made with before tax dollars and reduce their taxable income and their adjusted gross income contributions to a roth 401 k are made with after tax dollars and do not impact taxable income further employees are also responsible for choosing the specific investments held within their 401 k accounts from a selection that their employer offers those offerings typically include stock and bond mutual funds and target date funds designed to reduce the risk of losses as the employee approaches retirement 718an employee s account holdings may include guaranteed investment contracts issued by insurance companies and sometimes the employer s own stock 18contribution limitsthe maximum amount an employee or employer can contribute to a 401 k plan is adjusted periodically to account for inflation which measures rising prices for 2024 the annual limit on employee contributions to a 401 k is 23 000 annually for workers under age 50 however those aged 50 and over could make a 7 500 catch up contribution 19if your employer also contributes or if you elect to make additional nondeductible after tax contributions to your traditional 401 k account there is a total employee and employer contribution amount for the year 20employer matchingemployers who match employee contributions use various formulas to calculate that match for instance an employer might match 0 50 for every 1 that the employee contributes up to a certain percentage of salary vanguard estimates that about four in 10 companies have 401 k matching contributions of up to 6 of their employees wages only 10 of companies offer more than that 21lazaroff who also hosts the investment education podcast the long term investor said that if you can take advantage of your employer s matching contributions you should 22 it s a risk free way to grow your money and not leave part of your compensation on the table meeting the match doesn t necessarily mean you have to sacrifice other financial goals such as paying down debt or establishing an emergency fund he said you can still chip away at debt and put away small amounts in an emergency fund if necessary but securing that employer match is crucial employer contributions can be made to a traditional 401 k account and a roth 401 k withdrawals from the former will be subject to tax whereas qualifying withdrawals from the latter are tax free 1617contributing to both a traditional and a roth 401 k if your employer offers both types of 401 k plans you can split your contributions putting some money into a traditional 401 k and some into a roth 401 k 17however the total contribution to the two types of accounts can t exceed the limit for one account 23 000 for those under age 50 in 2024 2017 even though everyone has different circumstances in general you should try to put in the maximum allowable amount in your 401 k said lazaroff the investopedia top 10 financial advisor 