What is a 401(k)?

Have you thought about when you’re going to retire? It’s never too early to start saving, and 401(k) could be an option available to you.

A 401(k) is a company-sponsored retirement savings plan that has tax advantages. Employers offer these plans as a benefit to their employees. If employees opt into the program, they agree to pay a percentage of their paycheck and have it deposited into the 401(k) account. From there, employers often will match a portion of that percentage or the whole amount.

Traditional vs. Roth

Traditional 401(k)s are when contributions are deducted from your gross income. This reduces your taxable income for the year and can be reported as a tax deduction. Basically, your money grows tax-free. As long as your money stays in the account, you don’t have to worry about paying any taxes until you reach the retirement age.

Roth 401(k)s take the taxes upfront from your after-tax income. This means your distributions will be tax-free when you reach retirement. You won’t have to pay any additional taxes on dividends, interest, or capital gains, and your money still grows. So when you retire, you don’t have to “settle up” with Uncle Sam.

NOTE: There are limitations to how much you can contribute to your 401(k). Check out what the limitations are each year by visiting the IRS website.


The goal of your traditional 401(k) is to save for retirement. If you withdraw your money before retirement, you will face a 10% early distribution tax. This is on top of the other taxes you have to pay (dividends, interest, and capital gains). How do you avoid this penalty? You have to wait until you are 59 ½ years old before you can start withdrawing from your 401(k) without penalty.

There are times when you need extra cash for a large purchase, like a vehicle or house. Some employers allow their employees to take a loan against their 401(k) contributions. Essentially, you are borrowing the money from yourself. As long as you stay with the company until that money is reimbursed, you won’t face the 10% penalty for early withdrawal. If you do leave, you will have to pay back the remaining amount as a lump sum to avoid the penalty.

Difference between IRAs

Not all employers offer 401(k)s. That’s okay. There is another retirement savings plan you can invest in called IRAs, or individual retirement accounts. These are not employer-funded but rather funded all by yourself. IRAs allow more flexibility since they are all about you and your goals. You can choose which financial institution to house your IRA savings, how much to contribute, and how you want to invest. If you have a 401(k), but like the sound of an IRA, good news! You can have both! Having both an IRA and 401(k) only further secures your financial future.

If you have questions about 401(k)s or wish to go over your retirement goals with a financial advisor, contact your local credit union to see what resources they have to offer!