Key Takeaways

● A 401(k) is a retirement savings plan that is sponsored by an employer.

● Contributions to a 401(k) can be invested into various financial products, such as stocks, mutual funds and bonds.

● Not all employers match their employees' contributions.

Understanding

The first 401(k) plan, was created in the early 1980s in the United States. It is an employer sponsored retirement savings plan with contributions from employees and employers.

Employees who meet the employer's eligibility requirements can sign up for a 401(k) contribute a percentage of their paycheck to an investment account and their employers may match part or all of that contribution.

The money in the account then goes to investments that the employee chooses which are managed by financial institutions.

How 401(k) plans work

The money contributed can be invested into a wide range of investment alternatives, including stocks, mutual funds, annuities and bonds. Employees determine how their contributions are invested.

Not all employers match their employees' contributions. A company's financial position and management system may affect the contribution matched.

Pros and cons of a 401(k)

401(k) plans have some advantages over other retirement savings plans, including:

There are tax advantages to contributing to a 401(k). These will depend on they type of 401(k), traditional or Roth among other things. Please consult a tax advisor to find out more about how this might impact you.

Some employers allow employees to borrow funds from their 401(k), and participants can make a hardship withdrawal when needed.

But 401(k) has drawbacks, too.

Withdrawing funds from a 401(k) plan before a participant hits the retirement age can result in a hefty penalty and income tax.

Furthermore, participants have to choose from the investment products selected by their employers, and the plan can incur high management and other service fees.