What is a Traditional 401(k) Plan?

A 401(k) plan is a retirement savings program provided by numerous American employers, offering tax benefits to participants. This program derives its name from a specific section of the U.S. Internal Revenue Code (IRC).

When enrolling in a 401(k), the employee consents to allocate a portion of each paycheck directly into an investment account. Employers may opt to match a portion or the entirety of this contribution. Participants are typically offered a range of investment options, commonly including mutual funds, from which they can select.

What is the Contribution Limit for a Traditional 401(k) Plan?

The maximum contribution limits for both employees and employers in a 401(k) plan are periodically adjusted to accommodate inflation, which reflects the increasing prices within an economy.

For the year 2024, employees under the age of 50 can contribute up to $23,000 annually to their 401(k) accounts. However, individuals aged 50 and above are eligible to make an additional catch-up contribution of $7,500.

In 2023, the annual contribution limit for employees under the age of 50 was $22,500. For those aged 50 and over, an extra catch-up contribution of $7,500 was permitted.

If your employer also contributes to your 401(k), or if you opt to make additional non-deductible after-tax contributions to your traditional 401(k) account, there exists a total combined contribution limit for the year.

How Does a 401(k) Earn Money?

Your contributions to your 401(k) account are allocated based on the investment options you select from the array provided by your employer. Typically, these options encompass various stock and bond mutual funds, along with target-date funds tailored to mitigate investment risks as retirement approaches.

The growth of your investment depends on several factors: the amount you contribute annually, whether your company matches your contributions, the performance of your investments, and the number of years remaining until retirement.

As long as funds remain untouched in your account, taxes on investment gains, interest, or dividends are deferred until withdrawals are made after retirement, unless you possess a Roth 401(k), in which case taxes are waived on qualified withdrawals in retirement.

Moreover, initiating a 401(k) at a young age holds the potential for substantial earnings, owing to the power of compounding. Compounding allows returns generated by savings to be reinvested into the account, thereby generating further returns.

Over many years, compounded earnings on your 401(k) account can surpass the sum of your contributions. This highlights how consistent contributions to your 401(k) can lead to significant growth over time.