How a 401k Plan Works

Unlike their other savings plans, employees make contributions to their 401(k)s directly from their salaries. Their employers can make matching contributions.

This is how a 401k plan works.

So, a 401(k) will reduce the amount you see on the bottom line of your pay slip by putting money aside for your retirement. It will also deliver tax advantages. Depending on the type of 401(k) you’re using, you’ll either pay your taxes before investing in the 401(k) but not have to pay tax when you withdraw the funds. Or you’ll put money in the 401(k) before paying tax but you’ll have to pay taxes when you retire and make withdrawals.

Because employers deduct 401(k) payments directly from salaries, you won’t notice the money coming out of your pay slip and moving into your 401(k). The danger, though, is that you also won’t notice the money your employer can add to that fund. That’s extra income that you can miss if you’re only looking at the bottom line.

401(k) contributions might not be pay that you can spend right now but it can boost your income. It’s money that you will be able to spend in the future—and because of the tax benefits, it can be worth a lot more when you receive it.