Common Questions About 401(k) Plans

Since it was created in 1978, the 401(k) plan has grown to become the most widely-used type of employer-sponsored retirement plan in the U.S. These plans provide millions of workers money to be invested for their retirement, and 401(k) plans have become a key benefit of a job for many employers across the state. 

What Is a 401(k) Plan?

A 401(k) plan is a retirement savings account that allows an employee to divert a portion of their salary into long-term investments. The employer may match the employee's contribution up to a certain limit.

A 401(k) is technically a qualified retirement plan, which means it is eligible for special tax benefits under Internal Revenue Service (IRS) guidelines. There are two versions that qualified plans come in: defined contribution or defined benefit, such as a pension plan. The 401(k) plan is a defined contribution plan.

That means the available balance in the account is determined by the contributions made to the plan and the performance of the investments. The employee must make contributions to it, and employer may choose to match some portion of that contribution or not. The investment earnings in a traditional 401(k) plan are not taxed until the employee withdraws that money. Typically, this happens after retirement when the account balance is entirely in the hands of the employee.

What Are the 401(k) Contribution Limits?

The maximum amount of salary that an employee can defer to a 401(k) plan, whether traditional or Roth, is $20,500 for 2022. Employees aged 50 and older are allowed to make additional catch-up contributions of up to $6,500 in 2022.

The maximum joint contribution by both employer and employee is $61,000 in 2022. People aged 50 and older are allowed to contribute $67,500 in 2022.

What Is the Roth 401(k) Variation?

The Roth 401(k) is an increasingly popular option, though it is not offered by all employers. This version of the plan requires the employee to immediately pay income tax on the contributions.

The tradeoff is that after retirement, the money can be withdrawn with no further taxes due on either the contributions or investment earnings.

What Are Some 401(k) Investment Options?

Typically, a company offers employees several choices of investment options if they offer 401(k) plans. These options are often managed by a financial services advisory group such as The Vanguard Group or Fidelity Investments.

The employee can choose one or several funds to invest in. Most of the options are mutual funds, and they may include index funds, large-cap and small-cap funds, foreign funds, real estate funds, and bond funds. They usually range from aggressive growth funds to conservative income funds.

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