In the United States, a 401(k) plan is an employer-sponsored defined-contribution personal pension (savings) account, as defined in subsection 401(k) of the U.S. Internal Revenue Code. Periodic employee contributions come directly out of their paychecks, and may be matched by the employer. This pre-tax option is what makes traditional 401(k) plans attractive to employees, and many employers offer this option to their full-time workers. 401(k) payable is a general ledger account that contains the amount of 401(k) plan pension payments that an employer has an obligation to remit to a pension plan administrator. This account is classified as a payroll liability, since the amount owed should be paid within one year.
There are two types of 401(k) plans: traditional and Roth. For traditional accounts, contributions may be deducted from taxable income and withdrawals are added to taxable income. For Roth accounts, contributions and withdrawals have no impact on income tax due to contributions originating from post-tax income. There are limits to contributions, rules governing withdrawals, and possible penalties.
At the end of the first quarter of 2026, assets held in 401(k) plans were estimated at $9.9 trillion, including $5.7 trillion held in mutual funds.
History Before 1974, some U.S. employers had been giving their staff the option of receiving cash in lieu of an employer-paid contribution to their tax-qualified retirement plan accounts. The U.S. Congress banned new plans of this type in 1974, pending further study. After that study was completed, Congress reauthorized such plans, provided they satisfied certain special requirements. Congress did this by enacting Internal Revenue Code Section 401(k) as part of the Revenue Act.See section 135(a) of the Revenue Act of 1978, Pub. L. No. 95-600, 92 Stat. 2763, 2785 (November 6, 1978). This occurred on November 6, 1978.
The first implementation of the 401(k) plan was in 1978, about three weeks after Section 401(k) was enacted, before the Revenue Act of 1978 even went into effect. Ethan Lipsig, of the outside law firm for Hughes Aircraft Company, sent a letter to Hughes Aircraft outlining how it could convert its after-tax savings plan into a 401(k) plan.
Ted Benna was among the first to establish a 401(k) plan, creating it at his own employer, the Johnson Companies (today doing business as Johnson Kendall & Johnson). Benna was trying to reduce the taxes due on a deferred-compensation bonus plan for bank executives, at a time when the top marginal income tax rate was 70%. Employees could contribute 25% of their salaries, up to $30,000 per year, to their employer's 401(k) plan.
Taxation There are two main types corresponding to the same distinction in an Individual Retirement Account (IRA); variously referred to as traditional vs. Roth, or tax deferred vs. tax exempt, or EET vs. TEE.
Traditional The tax-saving benefits from Traditional accounts (as measured by the difference in outcomes vs a normally taxed account) come from two factors. The first benefit equals the withdrawal amount multiplied by the difference in tax rates between contribution and withdrawal. Effective tax rates are used to incorporate the impact of contributions and draws on the saver's qualification for benefits from other income-tested programs.
Second, everyone always receives the same benefit as from a Roth account - permanently tax-free profits on after-tax savings. The conceptual understanding is that the contribution's tax reduction is the government investing its money alongside the saver's, for him to invest as he likes. They become co-owners of the account. The government's share of the account at withdrawal (its funding plus the tax-free profits earned by it), fully funds the account's withdrawal tax calculated at the contribution's tax rate. So the contribution's tax reduction is never a benefit, and profits are never taxed. The withdrawal tax is conceptually an allocation of principal between owners, not a 'tax', and there is no benefit 'from deferral'.
For pre-tax contributions, the employee still pays the total 7.65% payroll taxes (social security and medicare). If the employee made after-tax contributions to the 401(k) account, these amounts are commingled with the pre-tax funds and simply add to the 401(k) basis. When distributions are made, the taxable portion of the distribution will be calculated as the ratio of the after-tax contributions to the total 401(k) basis. The remainder of the distribution is tax-free and not included in gross income for the year.
Roth
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.
For accumulated after-tax contributions and earnings in a designated Roth account (Roth 401(k)), "qualified distributions" can be made tax-free. To qualify, distributions must be made more than 5 years after the first designated Roth contributions and not before the year in which the account owner turns age , unless an exception applies as detailed in IRS code section 72(t). In the case of designated Roth contributions, the contributions being made on an after-tax basis means that the taxable income in the year of contribution is not decreased as it is with pre-tax contributions. Roth contributions are irrevocable and cannot be converted to pre-tax contributions at a later date. (In contrast to Roth individual retirement accounts (IRAs), where Roth contributions may be recharacterized as pre-tax contributions.) Administratively, Roth contributions must be made to a separate account, and records must be kept that distinguish the amount of contribution and the corresponding earnings that are to receive Roth treatment.
Unlike the Roth IRA, there is no upper-income limit capping eligibility for Roth 401(k) contributions. Individuals who find themselves disqualified from a Roth IRA may contribute to their Roth 401(k). Individuals who qualify for both can contribute the maximum statutory amounts into either or a combination of the two plans (including both catch-up contributions if applicable). Aggregate statutory annual limits set by the IRS will apply.
Withdrawal of funds Generally, a 401(k) participant may begin to withdraw money from his or her plan after reaching the age of without penalty. The Internal Revenue Code imposes severe restrictions on withdrawals of tax-deferred or Roth contributions while a person remains in service with the company and is under the age of . Any withdrawal that is permitted before the age of is subject to an excise tax equal to ten percent of the amount distributed (on top of the ordinary income tax that has to be paid), including withdrawals to pay expenses due to a hardship, except to the extent the distribution does not exceed the amount allowable as a deduction under Internal Revenue Code section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year). Amounts withdrawn are subject to ordinary income taxes to the participant.
The Internal Revenue Code generally defines a hardship as any of the following.Smith, Allen. "IRS: Self-Certification Permitted for Hardship Withdrawals from Retirement Accounts ". Society for Human Resource Professionals. April 3, 2017.
Unreimbursed medical expenses for the participant, the participant's spouse, or the participant's dependent. Purchase of principal residence for the participant. Payment of college tuition and related educational costs such as room and board for the next 12 months for the participant, the participant's spouse or dependents, or children who are no longer dependents. Payments essential to prevent foreclosure or eviction from the participant's principal residence. Funeral and burial expenses. Repairs to damage of participant's principal residence.
Some employers may disallow one, several, or all of the previous hardship causes. To maintain the tax advantage for income deferred into a 401(k), the law stipulates the restriction that unless an exception applies, money must be kept in the plan or an equivalent tax deferred plan until the employee reaches years of age. Money that is withdrawn prior to the age of typically incurs a 10% penalty tax unless a further exception applies."Publication 575: Pension and Annuity Income ". Internal Revenue Service. 2007. This penalty is on top of the "ordinary income" tax that has to be paid on such a withdrawal. The exceptions to the 10% penalty include: the employee's death, the employee's total and permanent disability, separation from service in or after the year the employee reached age 55, substantially equal periodic payments under section 72(t), a qualified domestic relations order, and for deductible medical expenses (exceeding the 7.5% floor). This does not apply to the similar 457 plan.
As a response to the COVID-19 pandemic, the CARES Act allowed people to withdraw funds before the age of up to $100,000 without the 10% penalty due for 2020.
Loans Many plans also allow participants to take loans from their 401(k). The "interest" on the loan is paid not to the financial institution, but is instead paid into the 401(k) plan itself, essentially becoming additional after-tax contributions to the 401(k). The movement of the principal portion of the loan is tax-neutral as long as it is properly paid back. However, the interest portion of the loan repayments are made with after-tax funds but do not increase the after-tax basis in the 401(k). Therefore, upon distribution/conversion of those funds, the owner will have to pay taxes on (only) the interest funds a second time.Guerra, Tony. "Can You Use Your 401(k) Funds for Purchasing a Second Home Without Tax Penalties? " Demand Media. Retrieved on January 29, 2014.
The loan principal is not taxable income nor subject to the 10% penalty as long as it is paid back in accordance with section 72(p) of the Internal Revenue Code.(p) This section requires, among other things, that the loan is for a term no longer than 5 years (except for the purchase of a primary residence), that a "reasonable" rate of interest be charged, and that substantially equal payments (with payments made at least every calendar quarter) be made over the life of the loan. Employers, of course, have the option to make their plan's loan provisions more restrictive. When an employee does not make payments in accordance with the plan or IRS regulations, the outstanding loan balance will be declared in "default". A defaulted loan, and possibly accrued interest on the loan balance, becomes a taxable distribution to the employee in the year of default with all the same tax penalties and implications of a withdrawal.
Required minimum distributions (RMD)
The age at which required minimum distributions generally begin is 73 for people who reach age 73 before 2033, and 75 for those who reach age 74 after 2032. A participant in a workplace retirement plan may delay distributions until retirement unless the participant owns more than 5 percent of the business sponsoring the plan, although a plan may require distributions to begin earlier. The first distribution is generally due by April 1 of the year after the participant reaches the applicable age or, when the workplace-plan exception applies, retires. Later distributions are due by December 31 each year. Designated Roth accounts are not subject to required minimum distributions while the owner is alive. A failure to withdraw the full required amount may incur an excise tax of 25 percent of the shortfall, reduced to 10 percent if the shortfall is corrected within two years.