What is a 401(k)?

Ah, retirement. The “neverending weekend” of our career. Imagine – no more meetings that could have been an email, no more overflowing email inboxes, no more workplace pet peeves in general… just unlimited time to do, well, whatever you want.

But here’s the thing about not working – it takes work to get to that point. Whether you’re just starting out in your career or in the thick of it, you won’t regret planning for your “golden years”.

Enter the 401(k) – the gold standard of golden year planning.

If you’re reading this, you’re probably somewhat familiar with the 401(k) – 79% of Americans work for an employer that offers some form of 401(k) retirement plan. But not everyone knows the full impact these benefits can have on your financial planning, between that compound interest and some pretty sweet tax advantages.

Many employers also opt to 1-up their employers’ funds by making additional contributions. This means, in some cases, for every dollar the employee puts in, the employer matches it (up to a certain level, of course). Just like that, they’ve saved twice as much. It’s about as close to “free” money as an employee can get.

There are two basic types of 401(k)s:

With a traditional 401(k), employees can deduct their contributions from their paycheck. Since these payments are made pre-tax, it lowers their overall taxable income, saving some money up front. Still, this doesn’t get them out of paying taxes altogether – they’ll still have to pay taxes when it comes time to make a withdrawal.

In a Roth 401(k), funds are contributed post-tax. And since they already paid the tax on those dollars, they won’t have to pay later. So when retirement rolls around, they’ll be able to simply withdraw their cash, no questions asked.

In short, the main difference between traditional vs Roth boils down to one question: Would you rather pay taxes now or later?

How do employees use a 401(k)?

As of 2022, you are free to contribute up to $61,000/year (in total between employer and employee contributions) if you’re under 50, and $67,500 if you’re over 50.

But let’s be serious – not many of us can afford to contribute $60K a year, and that’s okay. The beauty of a 401(k) is its flexibility.

Consider the recent college grad. When they secure that first Big Grown-up Job, they may only be able to afford $50 a month. No shame in that, they’ll be surprised how quickly that monthly $50 adds up, especially with their employer chipping in an extra $50 in matching contributions.

Ten years down the line, their income (and retirement fund contributions) have grown significantly through smart investments. And because the 401(k) is a set-it-and-forget-it kind of deal, they check their balance once every couple of months, just to be sure they’re on track.

As they inch closer to retirement, they may choose to increase their contributions, either to play catch-up or to add a bit of extra padding.

And when retirement comes along, there it is – the nest egg they’ve built, ripe for the taking. (And now they’re thankful for their younger self and those $50 contributions.)

However an employee chooses to use their 401(k), it can help them build a stable rainy-day fund for retirement, major life milestones, or unforeseen circumstances.

How does a 401(k) impact employees?

With all the to-dos in the day-to-day, it’s easy to push future planning to the “I’ll do it tomorrow” list. But in the end, there’s nothing more motivating than knowing tomorrow is taken care of – so you can focus on the here and now.

55% of Americans feel they might not be able to afford retirement, and 68% of Americans who describe themselves as financially insecure say they experience anxiety. Securing a solid pathway to retirement can offer employees some reassurance about the future, freeing up some mindspace so they can be more present in their work and lives.

Knowing your tomorrow is secure makes your today more enjoyable. Employer-sponsored retirement packages can help employees feel more secure in their financial future, reducing stress and anxiety.

Why should employers offer 401(k)s?

A 401(k) is an investment in your employees’ wellbeing. The mental and physical health issues that can result from stresses and anxieties accompanying financial insecurity are very real. Neglecting these strains may end up costing employers much more in the long run.

There’s a clear link between mental health and financial wellness. Most Americans agree that money can be a major contributor to stress or anxiety. Plus, poor financial wellness among employees can cost up to $240,032 in lost productivity each year for an 1000-employee company. A 401(k) plan gives employees the support and tools to help alleviate the stress of chasing after financial security.

A generous retirement plan can also be a huge draw when it comes to hiring and retention (especially if it comes with some nice employer-sponsored matching). In the current job landscape, competitive pay is only the starting point. For employers to stay in the conversation, they’re going to have to step up their benefits game, and retirement packages like 401(k)s are one of the best ways to do that.

In addition to advantages in hiring and retention, 401(k)s offer tax advantages for employers. Employers are allowed to deduct, within limits, their contributions to employee 401(k)s from their income tax return. They can also defer taxation on elective deferrals and investment gains.

It can be difficult to focus on your work if you’re wringing your hands about the future, and it can be difficult for an employer to secure talent without an ample benefits package. A 401(k) plan is a benefit that can offer that security for both employee and employer.

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