401(k) plans

In the United States, a 401(k) plan is the tax-qualified, defined-contribution pension account defined in subsection 401(k) of the Internal Revenue Code. Under the plan, retirement savings contributions are provided (and sometimes proportionately matched) by an employer, deducted from the employee's paycheck before taxation (therefore tax-deferred until withdrawn after retirement or as otherwise permitted by applicable law), and limited to a maximum pre-tax annual contribution of $18,000 (as of 2017).

Other employer-provided defined-contribution plans include 403(b) plans for nonprofit institutions, 457(b) plans for governmental employers, and 401(a) plans. These plans may provide total annual addition of $54,000 (as of 2017) per plan participant, including both employee and employer contributions.

Per Helaine Olen, in the early 1970s a group of high earning individuals from Kodak approached the Congress to allow a part of their salary to be invested in the stock market and thus be exempt from income taxes. This resulted in section 401(k) being inserted in the then taxation regulations that allowed this to be done. The section of the Internal Revenue Code that made such a 401(k) plans possible was enacted into law in 1978. It was intended to allow taxpayers a break on taxes on deferred income. In 1980, a benefits consultant and attorney named Ted Benna took note of the previously obscure provision and figured out that it could be used to create a simple, tax-advantaged way to save for retirement. The client for whom he was working at the time chose not to create a 401(k) plan. He later went on to install the first 401(k) plan at his own employer, The Johnson Companies (today doing business as Johnson Kendall & Johnson). At the time, employees could contribute 25% of their salary, up to $30,000 per year, to their employer's 401(k) plan.

With either pre-tax or after-tax contributions, earnings from investments in a 401(k) account (in the form of interest, dividends, or capital gains) are tax-deferred. The resulting compounding interest with delayed taxation is a major benefit of the 401(k) plan when held over long periods of time. Beginning in the 2006 tax year, employees have been allowed to designate contributions as a Roth 401(k) deferral. Similar to the provisions of a Roth IRA, these contributions are made on an after-tax basis.

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