A 401(k) plan is primarily funded through employee contribution via pre-tax payroll deductions. Contributed money can usually be placed into numerous investments, including stocks, bonds, mutual funds and ETFs, depending on what options the employer offers through the plan. Like IRAs, the investments in a 401(k) are able to grow tax-free, but they are taxable when funds are withdrawn in retirement.
There are two features of 401(k) plans that make them a better option for retirement savings than IRAs. First, contribution limits for 401(k) plans are higher. For 2020, you can contribute up to $19,500 to a 401(k) plan, with an additional “catch-up” contribution limit of $6,500 if you’re age 50 or older.
Second, many employers offer matching contributions, which equals “free money” for plan participants. If your employer offers matching contributions, make sure you’re at least contributing enough to get the full match, otherwise you’re not taking full advantage of your total compensation package.
Some employers also offer Roth 401(k) options. If you opt for the Roth version, your contributions will be made with after-tax dollars and won’t be taxed upon withdrawal.
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