its name from the section in the Internal Revenue Code, 26 U.S.C. §
Employers can help their employee save for retirement while reducing
taxable income under this provision, and workers can choose to deposit
part of their earnings into a 401(k) account and not pay income tax on
it until the money is later withdrawn in retirement. Interest earned
on money in a 401(k) account is never taxed before funds are
Employers may choose to, and often do, match contributions that
workers make. The 401(k) account is typically administered by the
employer, while in the usual "participant-directed" plan, the employee
may select from different kinds of investment options.
Employees choose where their savings will be invested, usually,
between a selection of mutual funds that emphasize stocks, bonds,
money market investments, or some mix of the above.
Many companies' 401(k) plans also offer the option to purchase the
company's stock. The employee can generally re-allocate money among
these investment choices at any time. In the less common
trustee-directed 401(k) plans, the employer appoints trustees who
decide how the plan's assets will be invested.
Since 2006, another type of 401(k) plan is available. Participants in
401(k) plans that have the proper amendments can allocate some or all
of their contributions to a separately-designated Roth account,
commonly known as a Roth 401(k).
These "Roth" contributions will be collected and treated as after-tax
dollars; that is, income tax is paid or withheld in the year
contributed. Qualified distributions from a designated Roth 401(k)
account, including all income, are tax-free. (A traditional 401(k)
account is funded with pre-tax dollars and, in general, tax must be
paid when the original contribution and earnings are withdrawn.)
All employer matching funds are deposited into the account on a pretax
basis, even if the employee's contributions are all Roth
contributions. Employer contributions may be subject to vesting rules
set by the plan documents requiring the employee to reach a certain
number of years of service before they are entitled to keep the
For non-profit organizations the corresponding plan is found in 26
U.S.C. § 403(b) and for government entities it is 26 U.S.C. § 457,
although older plans were established under 457(g).