What is a 401(k)?
A 401(k) is a retirement savings plan sponsored by an employer that allows employees to save and invest a portion of their paycheck before taxes are taken out. This type of plan is named after a section of the U.S. Internal Revenue Code, specifically Section 401(k).
Key Features
- Tax Advantages: Contributions are made pre-tax, reducing your taxable income. Taxes are deferred until withdrawal during retirement.
- Employer Match: Many employers offer a matching contribution, which can enhance your overall retirement savings.
- Investment Options: Employees can choose from a variety of investment options, including stocks, bonds, and mutual funds.
Contribution Limits
As of 2023, employees can contribute up to $22,500 per year, with an additional catch-up contribution of $7,500 for those aged 50 and older.
Withdrawals and Penalties
Withdrawals made before the age of 59½ typically incur a 10% penalty in addition to regular income tax. However, there are certain exceptions for hardship withdrawals.
Conclusion
A 401(k) can be a powerful tool for long-term retirement savings, thanks to its tax advantages and potential for employer contributions. It is important to understand its rules and benefits to maximize your retirement savings effectively.