What to Know About 401k Plans

A 401k plan is one of employees' most popular retirement savings options. These accounts allow you to save tax-deferred, and many companies match part of your contributions.

It's essential to know how your 401k account works and what investment options you have available. Your choices will affect how quickly your money grows and how much you'll have in the future.

Contributions to a 401(k) plan are generally made on a pretax basis. They are deducted from an employee's paycheck and go directly into the account before payroll taxes are withheld. This reduces the employee's taxable income and helps them in retirement by reducing their overall tax bill when they withdraw their savings through withdrawals or a lump sum distribution.

Most 401(k) plans also offer an employer match. These are contributions from an employer that are matched by the employee, generally up to 6 percent of their annual pay.

Some 401(k) plans offer a health savings account (HSA), a tax-advantaged plan that allows employees to set aside pretax money for healthcare expenses. This can include medical care, procedures or supplies, and even adult-care or child-care costs.

Many 401k plans include an employer match, meaning that your employer contributes up to a certain percentage of the money you save. This is a great way to boost your retirement savings and shows that you're invested in your future.

Depending on your 401k plan, you may get a dollar-for-dollar match or a partial match. For example, your employer may match 50% of your contributions up to 6% of your salary.

However, remember that these matching contributions may be capped at a specific amount. For instance, if your employer offers a 50% match, you can only contribute $1,200 to get the maximum benefit.

Additionally, employer matches often come with a vesting schedule. This means you will receive the total amount of your matching contribution once you've worked for the company for a certain period. This can encourage employees to stay with a company for longer, which can help you retain and recruit talent.

401k plans offer an array of tax-free earnings, including contributions and earnings from investments like stocks and mutual funds. This tax-deferred growth can significantly reduce your taxable income and take a big bite out of your tax bill.

But there's a catch: Early withdrawals from a tax-deferred 401k plan usually incur taxes plus a 10% penalty, so you should avoid taking out money prematurely.

The IRS says you can withdraw from a traditional 401k without paying tax or penalties if you have "an immediate and heavy financial need." Such needs include unreimbursed medical expenses, a child's education expenses, and other emergencies not covered by insurance.

You can also borrow from your 401k savings, although the rules differ from plan to plan. Generally, you must repay your loan within five years and make regular payments. Check with your employer's plan administrator to learn more about 401k loans.

Choosing which investments to put your money in is one of the most important decisions when investing in a 401k plan. The assets you select can determine the amount of your account's growth and income you'll have in retirement, so you must pick funds that will maximize your returns over the long term.

Employers and 401k-plan providers use various techniques to pick investments for their plans. They may look at fund company expense ratios, Morningstar or Lipper rankings, risk statistics, and past performance.

They also evaluate whether a fund stays with its stated objective and stays in the market, Brambley says. However, they can only sometimes be sure that a fund will perform well.

Rather than trying to time the markets, experts recommend sticking with low-cost funds and consistently investing over time. This will help your contributions grow faster and give you the best chance of reaching your retirement goals.