What is a 401k?

Answer 1

It is a deferred tax retirement account. You put money into it from your paycheck. This money comes out before you pay taxes and that means you can actually give a little more. Once the money is inside the account, it can be invested in a few different ways. The growth that happens in a 401k happens without being taxed. Ever. The money only becomes taxed if you withdraw it from the account. This means that the money can really grow. Normally, if you buy a mutual fund, there is a ton of taxes that have to be paid on it every year. This reduces the amount of growth you can experience. With a 401k, that money that would have gone to taxes will instead go where it can grow more for you. There are limits on when you can withdraw it too. If you take it out before you are 59 and a half then there are penalties and then taxes.

The goal of this is to get you to save for your retirement. You put the money in from each paycheck (it would be setup as an automatic withdrawl) and then let it grow. When you are ready to retire, it should be a very nice nest egg to pay for life so that you do not have to work until you are 99.

This is an overly simple explanation of it. There is a lot more you need to know. However, the key to 401k is to start early. If you start at age 22 then you can acquire a fortune. If you start at age 35 then you can acquire a fortune, just not nearly as big. If you wait until you are 50, then you will have a nice bit of money saved up but nothing you can live off of.

Answer 2

The 401(k) plan is a type of employer-sponsored retirement plan in the United States and some other countries, named after a section of the U.S. Internal Revenue Code. A 401(k) plan allows a worker to save for retirement while deferring income taxes on the saved money and earnings until withdrawal. The employee elects to have a portion of his or her wage paid directly, or "deferred", into his or her 401(k) account. In participant-directed plans (the most common option), the employee can select from a number of investment options, usually an assortment of mutual funds that emphasize stocks, bonds, money market investments, or some mix of the above. Many companies' 401(k) plans also offer the option to purchase the company's stock. The employee can generally re-allocate money among these investment choices at any time. In the less common trustee-directed 401(k) plans, the employer appoints trustees who decide how the plan's assets will be invested.

All assets in 401(k) plans are tax deferred. Before the January 1, 2006 effective date of the designated Roth account provisions, all 401(k) contributions were on a pre-tax basis (i.e., no income tax is withheld on the income in the year it is contributed), and the contributions and growth on them are not taxed until the money is withdrawn. With the enactment of the Roth provisions, participants in 401(k) plans that have the proper amendments can allocate some or all of their contributions to a separate designated Roth account, commonly known as a Roth 401(k). Qualified distributions from a designated Roth account are tax free, while contributions to them are on an after tax basis (i.e., income tax is paid or withheld on the income in the year contributed). In addition to Roth and pre-tax contributions, some participants may have after-tax contributions in their 401(k) accounts. The after-tax contributions are treated as basis and may be withdrawn without tax. The growth on after-tax amounts not in a designated Roth account are taxed as ordinary income.

Buy the truth and do not sell it; get wisdom, discipline and
understanding.

Proverbs 23:23, New International Version