A 401(k) is an employer sponsored and administered retirement savings plan. Like a traditional IRA, any money you deposit into a 401(k) is considered tax-deferred, a term that simply means that the IRS won’t tax your yearly contributions to the account, so it has the power to greatly reduce your annual tax bill. (Alas, the government’s patient; it will take its pound of flesh when you withdraw the money during your retirement.)
There’s some big advantages that 401(k)s have over other types of retirement accounts. Many companies will match a portion of the income you contribute, or even deposit a set amount into your account annually, which provides a turbo charge to your savings. 401(k)s also have comparatively high annual maximum contribution limits—between you and your employer’s contribution, you’re eligible to put away $55,000 per year, or $61,000 for our 50 and older friends.
The one major downside to 401(k)s is flexibility; since employers administer them, you will be limited to only a few investment plan options. But this is a small price to pay for all that free money your company’s kicking in for your retirement. And should you leave the company where you started your 401(k), you’re free to roll over any money in your account into a traditional IRA — at which point all the investment decisions will be yours and yours only.