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What is a 401(k) Plan?

A retirement plan is a simple way to save

A 401(k) plan is a retirement benefit offered to you by your employer. It can be an easy way to save for your future and can help you achieve financial independence. Imagine the possibility of having money for traveling, hobbies, and family time during your retirement.

Your retirement plan has many advantages

  • Easily pay yourself first — Once you decide how much to contribute to your retirement account, your contributions come directly out of your paycheck.
  • Contributions aren't taxed while invested — You don't pay federal taxes (or state or local taxes, in most cases) on your contributions while they're invested in the plan. If you make pretax contributions, you instead pay taxes when you withdraw the money and it's possible you'll be in a lower tax bracket at that time.
  • Tax-deferred earnings — Earnings on your contributions are not taxable until you withdraw them from your account. That way, your money can grow more quickly, because it's not being taxed while invested.
  • Employer contributions — Your employer may also make contributions to your account — such as matching your contributions up to a certain amount or sharing profits with you when the company performs well. This means that your employer is giving you a helping hand toward saving for retirement.
  • Variety of investment options — You may choose from the investment options in your plan, which are designed to offer you flexibility and help you save for retirement.
  • Portability — If you leave your job for any reason, the money you contributed to the plan is yours to keep. And if you are vested in your employer's contributions, any money they have contributed to your account is also yours. This means that the money can be moved to another retirement account or can be withdrawn (taxes and penalties may apply). You may even be able to leave your money where it is.

Taking money out of your retirement plan

Because 401(k) plans are designed to help you save for retirement, there are rules that limit access to your money while you are employed and before you retire. Most plans allow you to take money out of your account in the following cases:

  • When you retire
  • When you leave your job, regardless of your age
  • Upon death or disability
  • At age 59½, if you're still working (referred to as an “in-service” distribution)

Loans

Some retirement plans allow you to take loans from your account. However, borrowing from your retirement plan could reduce your income during retirement. When you take a loan from your retirement plan, loan payments are taken directly out of your paycheck. If you leave your job and have an outstanding loan balance, you have to pay off the remaining balance or pay additional taxes and penalties.