In the United States, a 401(k) plan is the tax-qualified, defined-contribution pension account defined in subsection 401(k) of the Internal Revenue Code.[1] Under the plan, retirement savings contributions are provided (and sometimes proportionately matched) by an employer, deducted from the employee’s paycheck before taxation (therefore tax-deferred until withdrawn after retirement or as otherwise permitted by applicable law), and limited to a maximum pre-tax annual contribution of $18,500 (as of 2018).[2][3]

Other employer-provided defined-contribution plans include 403(b) plans for nonprofit institutions, 457(b) plans for governmental employers, and 401(a) plans. These plans may provide total annual addition of $55,000 (as of 2018) per plan participant, including both employee and employer contributions.


In the early 1970s a group of high earning individuals from Kodak approached Congress to allow a part of their salary to be invested in the stock market and thus be exempt from income taxes.[4] This resulted in section 401(k) being inserted in the then taxation regulations that allowed this to be done. The section of the Internal Revenue Code that made such 401(k) plans possible was enacted into law in 1978.[5] It was intended to allow taxpayers a break on taxes on deferred income. In 1980, a benefits consultant and attorney named Ted Benna took note of the previously obscure provision and figured out that it could be used to create a simple, tax-advantaged way to save for retirement. The client for whom he was working at the time chose not to create a 401(k) plan.[6] He later went on to install the first 401(k) plan at his own employer, the Johnson Companies[7] (today doing business as Johnson Kendall & Johnson).[8] At the time, employees could contribute 25% of their salary, up to $30,000 per year, to their employer’s 401(k) plan.[9]


Income taxes on pre-tax contributions and investment earnings in the form of interest and dividends are tax deferred. The ability to defer income taxes to a period where one’s tax rates may be lower is a potential benefit of the 401(k) plan. The ability to defer income taxes has no benefit when the participant is subject to the same tax rates in retirement as when the original contributions were made or interest and dividends earned. Earnings from investments in a 401(k) account in the form of capital gains are not subject to capital gains taxes. This ability to avoid this second level of tax is a primary benefit of the 401(k) plan. Relative to investing outside of 401(k) plans, more income tax is paid but less taxes are paid overall with the 401(k) due to the ability to avoid taxes on capital gains.

For pre-tax contributions, the employee does not pay federal income tax on the amount of current income he or she defers to a 401(k) account, but does still pay the total 7.65% payroll taxes (social security and medicare). For example, a worker who otherwise earns $50,000 in a particular year and defers $3,000 into a 401(k) account that year only reports $47,000 in income on that year’s tax return. Currently this would represent a near-term $750 saving in taxes for a single worker, assuming the worker remained in the 25% marginal tax bracket and there were no other adjustments (like deductions). The employee ultimately pays taxes on the money as he or she withdraws the funds, generally during retirement. The character of any gains (including tax-favored capital gains) is transformed into “ordinary income” at the time the money is withdrawn.

Beginning in the 2006 tax year, employees have been allowed to designate contributions as a Roth 401(k) deferral. Similar to the provisions of a Roth IRA, these contributions are made on an after-tax basis.

If the employee made after-tax contributions to the non-Roth 401(k) account, these amounts are commingled with the pre-tax funds and simply add to the non-Roth 401(k) basis. When distributions are made the taxable portion of the distribution will be calculated as the ratio of the non-Roth contributions to the total 401(k) basis. The remainder of the distribution is tax-free and not included in gross income for the year.

For accumulated after-tax contributions and earnings in a designated Roth account (Roth 401(k)), “qualified distributions” can be made tax-free. To qualify, distributions must be made more than 5 years after the first designated Roth contributions and not before the year in which the account owner turns age 59½, unless an exception applies as detailed in IRS code section 72(t). In the case of designated Roth contributions, the contributions being made on an after-tax basis means that the taxable income in the year of contribution is not decreased as it is with pre-tax contributions. Roth contributions are irrevocable and cannot be converted to pre-tax contributions at a later date. (In contrast to Roth individual retirement accounts (IRAs), where Roth contributions may be re characterized as pre-tax contributions.) Administratively, Roth contributions must be made to a separate account, and records must be kept that distinguish the amount of contribution and the corresponding earnings that are to receive Roth treatment.

Unlike the Roth IRA, there is no upper income limit capping eligibility for Roth 401(k) contributions. Individuals who find themselves disqualified from a Roth IRA may contribute to their Roth 401(k). Individuals who qualify for both can contribute the maximum statutory amounts into either or a combination of the two plans (including both catch-up contributions if applicable). Aggregate statutory annual limits set by the IRS will apply.[10]

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