401K Plans

By Jon Scott

In this article, we’ll cover

  • What is a 401(k) plan

  • Investing your 401(k) contributions

  • Traditional versus Roth 401(k) plans

  • Employer Matching

  • Using your 401(k) to fund an early retirement

What is a 401(k) plan?


So what is a 401(k)? The 401(k) was actually not meant to be the primary retirement vehicle for workers. The Revenue Act of 1978 included Section 401(k), which gave employees a tax-free way to defer compensation from bonuses or stock options, with the law going into effect on January 1, 1980. In fact, experts from the Economy Policy Institute declared 401(k) plan a “poor substitute” for the pension plans workers enjoyed for much of the 20th century *sighs in Millenial and Gen Z*. By 1981 the IRS ruled that employees could contribute to their 401(k) plans via salary reductions. By 1990, 401(k) plans had 19 million participants and $384 billion in assets. As of September 30, 2022 401(k) plans held $6.3 trillion in assets on behalf of some 60 million active participants and millions of former workers and retirees.

401(k) programs enriched Wall Street, and also alleviated the responsibilities of corporations across the country. The majority of Americans' retirement will be largely self-funded, so how do you go about securing the ability to retire comfortably? The good news is, 401(k) plans are very flexible, and this article will show you ways you can use 401(k)’s to your advantage.


Instead of 401(k) plans, 403(b) plans are offered by public schools and other non-profit entities. These plans function differently than 401(k) plans. We’ll be updating the Knowledge Base with an article on 403(b) plans next week.

Yes, you should be investing your 401(k) dollars

401(k) contributions are meant to be invested, that’s why investment gains grow tax free. A very large portion, if not most, of the money in your 401(k) will come from investment gains. 401(k) plans typically offer a range of investments you can select, including Mutual Funds, Exchange Traded Funds (ETFs), real estate funds, and bond funds. Within mutual fund and exchange traded funds, you will find options for index funds that include large, medium, and small cap stocks. For real estate, you will likely find Real Estate Investment Trusts (REITs). For bonds you will find corporate or municipal bond funds or a mix of funds that include US government treasuries.

Traditional versus Roth 401(k) plans

401(k) plans are offered by employers in two flavors, traditional and Roth. The difference between the two lies in how they are taxed. Traditional 401(k) plans are labeled as pre-tax, meaning taxes are not taken from your contributions. The contributions grow tax free in your 401(k) once invested. At age 59 ½ , you are able to withdraw these contributions without penalty, however you will pay taxes at the time of withdrawal equal to your current income tax bracket at the time of withdrawal.


The benefit of the traditional 401(k) is that the contribution amount reduces your taxable income at the time of contribution. For example, if you made $95,000 you can contribute up to $22,500 to your 401(k) plan. All else being equal (not taking into account other tax free deductions you may elect) you will reduce your taxable income to $72,500, meaning your total earnings will be taxed at the highest rate of 22% for all earnings over $41,776; instead of the last roughly $6,000 (if you made no 401(k) contributions) of your income being taxed at 24%--as would be the case using 2023 tax brackets.

As you may have guessed, a Roth 401(k) plan is largely the opposite of the traditional plan. Taxes are taken out of your contributions initially (post-tax). Gains also grow tax free. The benefit here is that if you believe your tax bracket will be higher in the future–whether due to tax rate increases enacted by the government in the future and/or the fact that you’ll simply be making more money–you can use the Roth plan to take the tax hit initially and withdraw your contributions and gains completely tax and penalty free after age 59 ½.

Employer Match

Employers often match contributions. However, there are different methods of matching and match percentages. The first is a full (100%) match. For example, an employer might match 100% of your contributions up to 4%, meaning they will match your contribution dollar for dollar up to 4% of your salary (i.e. a salary of $100,000 with a 4% contribution would be a match of $4,000 for a total of $8,000). Partial matching means your employer will match part of the money contributed to your 401(k) plan up to a certain amount. For example, a salary of $80,000 per year and contribution of 6% with an employer matching 50% of your contributions up to 6%, would equal $7,200 in 401(k) dollars ($4,800 contribution and $2,400 matched by your employer).


If nothing else, always contribute up to the employer match.


Though 401(k) accounts are geared toward retirement, they are typically incredibly liquid accounts. However, parameters differ across 401(k) providers so you will want to familiarize yourself with those rules before loaning or withdrawing any funds.


401(k) loans let you borrow money from your 401(k) and pay it back overtime. These loans come with interest, but the beneficial part is those interest payments simply go back into your account. Typically, loans allow you to withdraw 50% of your contributions up to $50,000 over a 12 month period, with the requirement to pay this money back within 5 years of the loan including interest. Another benefit of 401(k) loans is that any missed payments won’t affect your credit score, since you are simply paying back yourself. The bad news is the loan will likely need to be repaid before leaving your current job. If you are unable to pay back the loan before you leave your employer, you may owe a 10% penalty on the amount withdrawn if you are under age 59 ½.


Using 401(k) loans are helpful when you need to pay off high interest debt such as credit card debt, or for larger home improvement projects that raise your property value enough to offset the after-tax money you are using to pay off the loan and interest. However, it isn’t a great idea to pause your contributions to pay off your 401(k) loan; you will want to continue making your regular contributions even when taking out a loan to stay on track for retirement.

Using a 401(k) to fund an early retirement

Here is a little secret, you don’t have to be 59 ½ to withdraw money from your 401(k) plan tax free. There is an exception that allows you to withdraw money from your 401(k) plan tax free if you retire, quit, or are fired at age 55:

  • This applies if you leave your job at any point during the calendar year in which you turn age 55 or later.

  • The 401(k) plan you withdraw from must be with the employer that you are leaving if you are to access these funds before age 59 ½. Therefore, it is important to rollover any 401(k) plans dollars from former employers to your current employer before you retire.

  • IRA plans operate differently, so if you roll the money from your 401(k) into an IRA you must wait until age 59 ½.

401(k) Contribution Limits

Other 401(k) & Retirement Resources