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Account & Regulation

401(k)

An employer-sponsored retirement plan where employees defer part of their salary into tax-advantaged investments. Contributions are pre-tax, growth is tax-deferred, and many employers offer a matching contribution.

What is a 401(k)?

A 401(k) is a retirement savings plan offered by an employer, named after the section of the Internal Revenue Code that created it. Employees elect to defer a percentage of each paycheck into the plan, where the money is invested in a menu of mutual funds (and sometimes index funds or target-date funds) chosen by the plan administrator.

Key features

  • Pre-tax contributions: money goes in before federal income tax is withheld, lowering your taxable income for the year
  • Tax-deferred growth: investments grow without annual tax on gains, interest, or dividends
  • Employer match: many employers match a percentage of your contribution (a common formula is 50% match on the first 6% of salary you contribute). This is effectively free money
  • High contribution limits: well above what IRAs allow; IRS sets the annual limit with catch-up contributions at age 50+
  • Vesting schedules: employer match may not be fully yours until you've worked a set number of years
  • Taxed at withdrawal: distributions in retirement are taxed as ordinary income
  • Early withdrawal penalty: typically 10% before age 59½, on top of ordinary income tax

Priority of use

A common playbook: contribute at least enough to capture the full employer match first (never leave that on the table), then max out a Roth IRA or Traditional IRA for more investment options, then come back to the 401(k) to contribute more if you can.

The employer match is the most valuable tax break most workers ever get. Contribute at least up to the match even if you cannot do anything else.

Related Terms

403(b)

A retirement plan for employees of public schools, universities, churches, and certain nonprofits. Similar to a 401(k) in structure and contribution limits, with investments typically in annuities or mutual funds.

457(b)

A deferred compensation plan for state and local government employees and some nonprofits. Separate contribution limit from 401(k) and 403(b), and no early withdrawal penalty at separation of service.

Backdoor Roth

A two-step workaround that lets high earners get money into a Roth IRA despite the income limit: contribute non-deductibly to a Traditional IRA, then convert it to a Roth. Pro rata rule is the main trap.

Capital Gains Tax

Tax owed on profits from selling investments. Short-term gains (held under 1 year) are taxed as ordinary income. Long-term gains (held over 1 year) get lower rates.

HSA

A Health Savings Account: a triple-tax-advantaged account for medical expenses. Contributions are deductible, growth is tax-free, and qualified medical withdrawals are tax-free. Often used as a stealth retirement account.

Roth 401(k)

A 401(k) variant funded with after-tax dollars. Investments grow tax-free and qualified withdrawals in retirement are tax-free, combining the high contribution limits of a 401(k) with the Roth tax treatment.