What is a 401(k)?

I asked the good folks at nerdwallet, “What is a 401(k)?” This is what they said:

“A 401(k) is a savings and investing plan offered by employers that gives employees a tax break on money they set aside for retirement. The name comes from the section of the tax code — specifically subsection 401(k) — that established this type of plan. Employees contribute money to an individual account by signing up for automatic deductions from their paycheck. Depending on the type of plan you have, the tax break comes either when you contribute money or when you withdraw it in retirement.”

On the nerdwallet website they list a quick summary of the main features of a 401(k):

• A 401(k) is a tax-favored retirement savings account offered by employers
• Individuals can contribute up to $18,500 a year ($24,500 if age 50 or older)
• Some employers offer the choice of both a traditional 401(k) and a Roth 401(k)
• You can contribute to both a 401(k) and an IRA in the same year
• The biggest drawbacks of a 401(k) are plan fees and limited investment options
• If you leave your job, you can roll over your 401(k) money into an IRA

Next, I asked the folks at INVESTOPEDIA the same question: What is a 401(k)? Here’s what they had to say.

“A 401(k) plan is an arrangement that allows an employee to choose between taking compensation in cash or deferring a percentage of it to a 401(k) account under the plan. The amount deferred is usually not taxable to the employee until it is withdrawn or distributed from the plan. However, if the plan permits, an employee can make 401(k) contributions on an after-tax basis (these accounts are known as Roth 401(k)s), and these amounts are generally tax-free when withdrawn. 401(k) plans are a type of retirement plan known as a qualified plan, which means that this plan is governed by the regulations stipulated in the Employee Retirement Income Security Act of 1974 and the tax code.”

Next, I went to the IRS website and found this:

“A 401(k) plan is a qualified (i.e., meets the standards set forth in the Internal Revenue Code (IRC) for tax-favored status) profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan under which an employee can elect to have the employer contribute a portion of the employee’s cash wages to the plan on a pre-tax basis. These deferred wages (elective deferrals) are generally not subject to federal income tax withholding at the time of deferral and they are not reflected as taxable income on your Form 1040, U.S. Individual Income Tax Return.

The amounts deferred under your 401(k) plan are reported on your Form W-2, Wage and Tax Statement. Although elective deferrals are not treated as current income for federal income tax purposes, they are included as wages subject to Social Security (FICA), Medicare, and federal unemployment taxes (FUTA). Refer to Publication 525, Taxable and Nontaxable Income, for more information about elective deferrals. Refer to the Form W-2 Instructions for more information on how amounts should be reported.”