The 401(k) is an employer-sponsored retirement savings plan named for chapter 401, subsection k, of the 1978 Internal Revenue Code that allows you to set aside funds, pre-tax, from your paycheck.
With a 401(k), you control how your money is invested. Most plans offer a spread of mutual funds composed of stocks, bonds and money market investments. Target-date funds, which combine stocks and bonds that gradually become more conservative as you near retirement, are popular options.
Many employers offer 401(k)s. These plans present employees with an automatic savings device, provide tax breaks and in some cases, offer an added benefit when employers match the employee's contributions.
Employees are not taxed on the money contributed to the plan or on plan investment earnings until they receive distributions.
There is a limit on the amount you may contribute to employer-sponsored retirement plans, as well as the amount of any employer match, subject to annual cost of living increases. At the employer's option, the plan may allow additional "catch-up" contributions for persons 50 years or older.
Visit the IRS website for more information on current limits. In most cases, you can't tap into your employer's contributions immediately. "Vesting" refers to the amount of time you must work for your company before gaining access to its payments to your 401(k). Also, keep in mind that there are rules about when you can withdraw your money and costly penalties for pulling funds out before you reach retirement age.