The definition of a 401K is a type of retirement plan. With a 401K an employee tells the employer to take a certain percentage of their wages and invest it.
A 401K plan has several benefits:
- Tax benefits - You will not have to pay taxes on the money you invest into a traditional 401K plan – at least until you withdraw it, which may be years from now.
- Employer matching funds - Your employer might match the funds you put into your 401K plan up to a specific percentage of your wages. If so, this employer-contributed money is like "free money" on which you will earn interest.
It is to your benefit to start this investing process now, so that the money has time to grow for your future.
There are two types of plans - a traditional 401K and a Roth 401K:
- In a traditional plan, you will not pay taxes on the wages you invest until you withdraw the funds.
- In a Roth 401K plan, you will pay taxes on your wages now so that you won't have to worry about paying taxes on the invested funds when you draw them out of the account in the future. Some employers choose the Roth 401K option for their workers, and you might have the option to switch into this plan if it has not already been established for you as an employee.
An example of a 401K is a retirement account offered by employers that allows employees to put a percentage of their income into a tax-deferred account into which employers may add matching funds.