401(k)

A 401(k) is a defined contribution retirement plan offered by US employers and named after section 401(k) of the Internal Revenue Code. Employees choose a percentage of their salary to pay in through payroll, up to an annual limit set by the IRS, with a higher limit for older workers. In a traditional 401(k), contributions are made before income tax and the money grows tax-deferred, with withdrawals taxed as income. Many plans also offer a Roth 401(k) option, where contributions are made after tax and qualified withdrawals are tax-free. Investment choices are limited to the menu of funds the plan offers.

The employer match is often the most valuable feature: many employers add, for example, 50 cents or a dollar for every dollar an employee contributes, up to a percentage of salary, which is effectively an immediate return. Matching contributions may be subject to vesting, meaning you keep them only after a period of service. Withdrawals before age 59½ generally incur a 10% additional tax on top of income tax, with some exceptions, and minimum withdrawals are required from traditional accounts later in life. When changing jobs, the balance can usually stay put or be rolled into an IRA or a new employer’s plan. The UK equivalent is a workplace defined contribution pension.