Most 401(k) contributions reduce your taxable income for the year, but then you must pay taxes on your distributions in retirement. But if you have a Roth 401(k), you pay taxes on your initial contributions and your money grows tax-free afterward.
You usually can't withdraw your 401(k) funds when you're under age 59 1/2, unless you have a qualified reason, like a large medical expense. Otherwise you'll pay a 10% early withdrawal penalty. Some plans allow 401(k) loans -- you withdraw a sum and pay it back with interest over time -- but it's up to each employer to decide whether to offer this.
If you decide to leave the company, you may take your 401(k) with you, rolling it over into your new employer-sponsored retirement plan or into an IRA you open on your own.
What are the types of defined contribution plans?
A 401(k) isn't the only type of defined contribution plan. Here are a few others you may have heard of:
- 403(b): A 403(b) is similar to a 401(k), but it's available only to public school employees, certain ministers, and employees of nonprofit organizations.
- 457: This is a special type of retirement plan reserved for state and local government employees and some nonprofit workers.
- Thrift Savings Plan: These are available exclusively to employees of the federal government and members of the uniformed services, including military members, police officers, and firefighters.
- Employee stock ownership plans: These plans give employees an ownership interest in their company and also provide tax benefits.
- Profit sharing plans: A profit sharing plan regularly gives employees a portion of their company's profits.
