Account Types: 401k Account (Part 2 of a 5 Part Series)
/This week I am covering what a 401k is and how it differs from the Roth IRA account discussed last week.
A 401k is a type of retirement savings plan offered through many employers. There are limits to how much can be contributed to these accounts each year, but the limits are much higher than what you can contribute to a Roth IRA ($20,500 for 2022; +$6,500 for age 50+ catch-up contributions). You can contribute up to 100% of your gross earnings, or up to the annual contribution limit each year, whichever is less. Some companies will match contributions made to a 401k, some do not.
Contributions to a traditional 401k will reduce your current taxable income dollar for dollar. Investments made in the account then grow tax-deferred, and you pay taxes on each dollar you withdraw later in life. In the year you turn age 72, annual Required Minimum Distributions will begin, meaning you are obligated to take a taxable distribution each year thereafter.
Finally, some employers offer a Roth 401k option, which means contributions do not reduce taxable income and instead grow tax-deferred toward future tax-free withdrawals.
