What is a 401(k) or a 403(b) Plan?



What is a 401(k) or a 403(b) Plan?



A 401(k) (or 403(b)) is a tax-deferred retirement savings plan sponsored by your employer. It allows you (employee) to save and invest a part of your paycheck. You do not pay taxes on this money until you withdraw it from the account.

401(k) plans came along as a ‘Defined Contribution Plans’ in 1980s as a supplement to pensions or ‘Defined Benefits Plans.’ The Pension funds were/are managed by the employer and they paid/pay retired employees income over their course of the retirement. As avoid risks and also high cost of running pension plans, most employers have replaced them with 401(k)s. The employer provides a ‘defined contribution’ (a few % of what employee invests every pay check) as a match.

Most 401(k) plans offer a few mutual funds composed of domestic and international exposure stocks, bonds, stable value/money market investments. Many offer target-date funds which are a combination of stocks and bonds that become more conservative as you/employee reaches your retirement.

There are a few restrictions when it comes to investing in 401(k) plans. You can’t access your employer’s contributions until you are fully vested in your company (typically 5 years). Your own investment money is vested immediately.

Note that there are many rules about when you can withdraw your money and there are costly penalties for taking funds out before retirement age.