A 401(k) is an employer-sponsored retirement plan that allows employees to contribute a certain percentage of their pay into a tax-advantaged account, and then determine how they would like to invest.
These types of plans are the most common retirement benefits offered to employees, according to a recent report by the Transamerica Center for Retirement Studies. More than half of employers offer a 401(k) or a similar type of defined contribution plan, per Transamerica. Nearly 90% of companies with more than 100 employees have one, compared to 46% of small businesses.
There’s a good reason why: employees like them. Roughly 80% of workers participate in a 401(k)-type plan when offered, per Transamerica, saving 12% of their pay.
Why do employers offer them? The top three reasons include:
- Help employees save and prepare for retirement (57%)
- Increase job satisfaction among employees (55%)
- Inspire loyalty among employees (50%)
There are two main types: Traditional 401(k)s and Roth 401(k)s.
In a traditional 401(k), contributions are made before income taxes are applied, thereby lowering your current tax bill to Uncle Sam. Your account then grows tax-free over time, and faces income taxes when you withdraw from your account.
A Roth 401(k) works in reverse. You pay the taxes up front, and then never have to cut a check to Washington again. This option makes sense for those in a lower tax bracket then they imagine they’ll be in when they start taking money out of their retirement account, typically decades in the future.