401(k)

The name is the subsection of the tax code that created the plan, and the plan is an account, not an investment: the money in it is held in whatever funds you pick from the plan's menu. You choose a percentage of pay, it leaves every paycheck before you see it, and in a traditional 401(k) it also leaves before federal income tax is computed, so a $300 contribution shrinks the paycheck by less than $300. The account grows untaxed until you withdraw from it, and withdrawals in retirement are taxed as ordinary income, a tax break now in exchange for tax later. Many plans also offer a Roth 401(k) option, where contributions go in after tax and qualified withdrawals come out tax-free.

In a sentence

• "I put 6% into the 401(k) and my employer matches half of it, so $450 a month goes in and $300 of it is mine."
• "When she changed jobs she rolled the old 401(k) into an IRA instead of cashing it out."
• "A 401(k) is opened through your employer; an IRA you open yourself, and you can have both."

How it works

1. Your employer sets up the plan and its rules: eligibility, the match formula, the vesting schedule and the fund menu. Many employers enroll new hires automatically at a default percentage you can change.
2. You choose a percentage of your pay, and it comes out of every paycheck through payroll. The IRS sets an annual limit on contributions, which changes most years, with a higher catch-up amount past an age it also sets.
3. Traditional contributions go in before federal income tax, lowering the wages the tax is computed on; Social Security and Medicare taxes are still taken on the full amount. Roth 401(k) contributions go in after tax.
4. The employer adds its match, if the plan has one, usually each pay period; the match becomes yours as it vests.
5. The money is invested in the funds you chose and grows without yearly tax on dividends or gains.
6. Withdrawals in retirement are taxed as ordinary income from a traditional 401(k) and tax-free from a Roth 401(k) when qualified. A withdrawal before the age the IRS sets costs income tax plus a 10% penalty, with a few exceptions, and required minimum distributions begin at an age the IRS also sets.

A 403(b) at a school or nonprofit and a 457 at a government employer work much the same way, and the account stays yours when you leave the employer.

An example

A $60,000 salary paid monthly, a 6% contribution, and a match of 50% of the first 6%.

The paycheck falls by less than the $300 that went in: federal income tax is computed on $4,700 instead of $5,000, so at the example's assumed 20% marginal rate take-home falls by $240 while $450 arrives in the account. Over thirty years at the example's assumed 6% annual return, $450 a month grows to about $452,000, $162,000 of it contributions; the $300 alone would reach about $301,000.

Why it matters

The 401(k) is where most working households do most of their saving, and the decisions are small and early: the percentage, whether it reaches the full match, and which funds hold the money. A contribution short of the match cap gives up pay the employer offered, and a percentage set at a first job is still the same percentage a decade of raises later. The other decision arrives at each job change: cashing out costs the tax and the penalty at once and restarts the growth from zero, and a plan left behind at a former employer is the account households most often forget.

401(k) versus IRA

A 401(k) comes through an employer, and an IRA is an account you open yourself at a brokerage or bank. The 401(k) is funded by payroll, may include a match, and has the higher annual limit; the IRA has no match and a limit that is a fraction of the 401(k)'s, but you choose the provider and the investments. The two are not exclusive: a household with a 401(k) can fund an IRA in the same year.

Common questions

Is a 401(k) the same as an IRA? No. Both are retirement accounts with the same traditional or Roth tax treatment, but a 401(k) is set up by an employer, funded through payroll and often matched; an IRA is opened by you at a provider you choose, with a lower annual limit and no match.

How much should I contribute to a 401(k)? At least enough to collect the full employer match, since less gives up pay the employer offered. Beyond that, a common rule of thumb for retirement saving is 10% to 15% of pay including the match, raised on the day of each raise.

What happens to my 401(k) when I leave my job? Your contributions and the vested match are yours. Leave the account in the old plan, roll it into an IRA or the new employer's plan with no tax due, or cash it out and pay income tax plus, before the age the IRS sets, a 10% penalty.

Can I take money out of a 401(k) early? At a cost: a withdrawal before the age the IRS sets is taxed as income plus a 10% penalty, with exceptions such as certain hardships. Many plans also let you borrow from the balance and repay it through payroll, which is a loan rather than a withdrawal.

Go deeper

• The Retirement calculator projects what your retirement savings could grow to by the age you plan to stop working, what that is worth in today's dollars, and the monthly income it could support.
• How to track a 401(k) or pension that doesn't connect keeps the plan on your net worth sheet from four quarterly statements a year.
• How to count a 401(k) loan, a HELOC, or a car lease in net worth records a loan against the account as a liability with the account still counted in full.
• How to calculate your savings rate adds the payroll contribution back to both sides of the rate.

Where it shows up in Zypper

Zypper counts the 401(k) at its balance. Investment and brokerage accounts, including 401(k), IRA and Roth IRA, and HSA accounts, connect wherever the provider supports a connection and contribute their balances to net worth every day; a plan that cannot be connected is a manual account with a name and a balance you set, counting toward net worth and changing only when you change it. A loan against the plan is a manual account on the liability side whose balance you set from the plan statement and lower as you repay. See Supported account types and Manual accounts for the details, or get started with Zypper to see the balance in your net worth.