Broker Check

What is a 401(K)?

| June 14, 2023

     A 401(k) is a defined contribution plan; an employer-sponsored retirement savings plan that lets the employee assume responsibility for their retirement income by making pretax contributions from his or her paycheck. 

     The Employee Retirement Income Security Act (ERISA) covers two types of retirement plans: Defined Benefit Plans and Defined Contribution Plans. A 401(k) is a defined contribution plan: the employee, the employer, or both contribute to the employee's individual account under the plan. Contributions go into a 401(k) account, with the employee often choosing the investments based on available options. Commonly, the employer also makes contributions by matching at a specified rate (typically 3% to 6%) the employees’ contribution. Other times it's just a flat percentage where the employee does not have to contribute to get the employer’s contribution.

     There is a dollar limit on the amount an employee may elect to defer each year. An employer must advise employees of any limits that may apply. In 2023 the maximum an individual can contribute to a 401(k) is $22,500. If you are age 50 or over, there is a catch-up contribution limit that allows you to contribute an additional $7,500. So, a total of $30,000 can be contributed by an individual over the age of 50.

     Most employers also offer a Roth 401(k) option to the defined contribution plan. The Roth feature allows you to contribute post tax dollars to the account; growth and distributions past age 59 1/2 are IRS penalty and income tax free in the future. 

How is a 401(k) different than an IRA? 

    Unlike a 401(K), an IRA is NOT an employer sponsored plan. IRAs also have phase-out ranges. If you are a high-income earner, you may not be able to tax deduct contributions into the IRA account. 


Roth IRA vs Roth 401(k)?

     A Roth IRA also has phase-out ranges where if you are a higher earner, you may not even be able to contribute to a Roth IRA at all. On the other hand, a Roth 401(k) doesn't have that level of limitation. 

When can you join your employer’s 401(k)? 

     You need to find out when you can begin to participate in the plan.  You can find this information in the Summary Plan Description through your HR department.  Federal law sets minimum requirements, but a plan may be more generous.  Generally, a plan may require an employee to be at least 21 years old and to have a year of service with the company before the employee can participate in a plan. Ask your Human Resource director for the details and take advantage of the opportunity. For more information about various retirement plans just reach out and a representative can help answer your questions or you can search through our blogs for more information.