What is a Traditional 401(k) Retirement Plan?
A traditional 401(k) is a retirement plan established by employers which lets employees save a portion of their earnings. It's funded with worker’s pre-tax dollars and employers contributions (if any). Both the growth of the funds and the employers contributions are tax-deferred. This means that taxes only get paid when money is withdrawn. In that sense, 401(k) plans are similar to Individual Retirement Accounts (IRAs), where the money cannot be withdrawn until the age of 59 and a half, except for special circumstances. However, most employers include an option of obtaining loans against 401(k) accounts.
These days, a 401(k) plan is typically offered in place of a traditional pension. It can be a very powerful tool to make up the difference between your Social Security payment and the pre-retirement earnings.
401(k) Benefits
- Your account balance can grow quickly: Not only are both the employer’s and employee’s contributions tax-free, but the growth of the funds are also tax-free.
- Lower taxes: Because contributions are tax-free, you may be eligible for a lower tax bracket, saving money on federal and (in most cases) state taxes.
- Portability: Take your 401(k) earnings with you if you switch employers. You can put it into the new employer's plan or roll it over to an Individual Retirement Account (IRA).
- Better control of your moneyYou can decide how and where your earnings get invested.
- Automatically fund your account: 401(k) plan is typically set up as payroll deductions, making saving easy.
- Increased Buying Power: You are able to invest in large managed funds that have high minimum investment requirements.
- Borrow from your Account: Most plans have a loan option letting you borrow from your own account with no penalties (or taxes), and pay it back to yourself, including the loan interest.
