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Simple English definitions for legal terms
401(k)
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A quick definition of 401(k):
A 401(k) is a type of retirement plan that an employer offers to their employees. It allows employees to save money for retirement and defer taxes until they withdraw the money. The employee can contribute up to a certain amount each year, and the employer may also contribute a certain amount. The money in the 401(k) account is invested, and the employee has limited options to choose from. If the employee withdraws money before they reach a certain age, they will have to pay a penalty tax. There is also a type of 401(k) called a Roth 401(k) which taxes contributions upfront but allows tax-free withdrawals in retirement.
A more thorough explanation:
A 401(k) is a type of retirement plan that an employer offers to their employees. It allows employees to save money for retirement while deferring taxes until they withdraw the money. The name comes from the section of the Internal Revenue Code that created it.
Employees can contribute a certain amount of their income to their 401(k) each year, up to a limit set by the government. Employers may also contribute to the plan, often matching a portion of the employee's contribution. For example, if an employee contributes $1000 to their 401(k), their employer may contribute an additional $500.
There are limits to how much a person can contribute to their 401(k) each year, and these limits change over time. In 2022, the limit is $20,500 for people under 50, and $27,000 for people over 50.
When a person reaches retirement age, they can begin withdrawing money from their 401(k). If they withdraw money before retirement age, they may have to pay a penalty. Once a person reaches age 72, they must begin taking a certain amount of money out of their 401(k) each year.
There are also Roth 401(k) plans, which work differently than traditional 401(k) plans. With a Roth 401(k), contributions are taxed before they go into the account, but withdrawals are tax-free. This can be beneficial for people who expect to be in a higher tax bracket when they retire.
Overall, a 401(k) is a way for people to save for retirement while deferring taxes. It's important to understand the contribution limits, withdrawal rules, and any employer matching programs when deciding whether to participate in a 401(k) plan.
John works for a company that offers a 401(k) plan. He decides to contribute 5% of his salary to the plan, which is $2500 per year. His employer also offers a matching program, where they will contribute 50 cents for every dollar John contributes, up to a maximum of $5000 per year. This means that John's employer will contribute an additional $1250 to his 401(k) each year.
Over time, John's contributions and his employer's contributions will grow through investment returns. When John reaches retirement age, he can begin withdrawing money from his 401(k) to support his retirement lifestyle.