401(k)s and Other Workplace Plans

Why this matters

A workplace plan is often the easiest way to invest steadily. Money leaves your paycheck before you can spend it, and some employers add money of their own. But the plan only works for you if you know what you've signed up for. This lesson explains how these plans work and what to look for in yours.

How a 401(k) works

In a 401(k), you choose to have part of your pay go into the plan instead of being paid to you. That choice is called an elective deferral. In a traditional 401(k), the money goes in before federal income tax, so it isn't counted as taxable income that year. Many plans also let you make some or all of your contributions as Roth contributions instead, which are taxed now and can come out tax-free later.¹

Employers can add to your account, either by matching what you put in or by contributing for every eligible employee, whether or not they contribute. Plans can also enroll employees automatically, taking contributions from pay unless the employee opts out.¹

403(b) and 457(b) plans

Other employers offer plans that work in much the same way:

• 403(b) plans are offered by public schools, colleges, and universities, churches, and charities that are tax-exempt under section 501(c)(3). The money is held in annuity contracts from insurance companies or in custodial accounts invested in mutual funds. They can offer Roth contributions too.²
• 457(b) plans are offered by state and local governments and some tax-exempt organizations.³ Two differences stand out. A 457(b) has its own contribution limit, separate from a 401(k) or 403(b), so someone offered both may be able to contribute the full amount to each.⁴ And withdrawals from a governmental 457(b) plan generally aren't subject to the additional 10% tax on early withdrawals that applies to 401(k)s and 403(b)s.⁵

Federal employees and members of the uniformed services have the Thrift Savings Plan, which shares the same yearly limit as a 401(k).⁶

The rest of this lesson is for members

Still to come in this lesson: How much you can put in, What to check in your plan, the key takeaways, and 2 quiz questions with explanations.

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