How does a 401(k) Plan work?


Of all the retirement planning options that are available to most
people, 401(k) plans may be one of the best programs for accumulating
retirement funds. Unlike a taxable savings vehicle, a 401(k) plan allows
you to make annual pre-tax contributions up to a certain amount
(Congress sets the maximum each year). Pre-tax contributions are much
better for savers than after-tax contributions.

For example, if you are in the 28 percent federal marginal tax bracket,
it effectively costs you only $72 of spendable income to save $100 for
retirement. And it works out even better for those in higher tax
brackets. And like other qualified retirement plans, a 401(k) allows
your money to grow tax deferred. This enables you to build capital
significantly faster than similar investments outside the shelter of a
qualified tax plan.