Many employers offer their workers 401(k) plans as a benefit to increase the value of a compensation package. The 401(k) plan gives employees the security of knowing that they will have money to support themselves once they retire.

How it Works

401(k) plans offer the benefit of not allowing any capital gains, interest, or dividends to be taxed until withdrawal. This means that money that is contributed to a 401(k) plan can be free from taxation. The money in a 401(k) account can be invested in a variety of stocks, bonds, mutual funds, or other assets. The 401(k) plan was created by Congress in 1981 to help individuals save for their retirement and is named 401(k) because of the section of the Internal Revenue Code that explains its workings.

401(k) Advantages

Taxation

As mentioned earlier, a 401(k) plan has the advantage of avoiding taxation by the government. This allows the interest, capital gains, and dividends to continually compound without taxes cutting into the bottom line profit. Over time, this can add up to be a substantial benefit over basic savings plans which are susceptible to taxes. Choosing a 401(k) plan over a savings account can possibly translate into living a comfortable retirement lifestyle versus simply scraping by.

Employers Match Contributions

Often, employers will match contributions made by an employee into their 401(k) plan up to a certain percent of the employee’s salary. Most employers agree to raise the percentage of contributions as the length of time an employee has been with the company increases. For example, employers might match 25 percent of a contribution made by an employee who has been with the company for a few months. For an employee who has been with a company for one to two years, the employer might match 50 percent of what the employee contributed to their 401(k) plan. In some cases, employers might match dollar for dollar, or one hundred percent, what the employee contributes. Some companies will even match contributions by more than 100 percent. These large contribution matches are generally reserved for employees who have been with a company for a long tenure and have demonstrated loyalty and quality work.

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