401k

A 401k is a type of investment plan in the United States. This investment plan is routinely relied on to fund retirement for Americans.

The 401k plan is an employer-sponsored contribution pension account. Many Americans prefer this type of plan as employee funding comes directly from a paycheck and may be matched by the employer.

These accounts have a large amount of appeal for American investors given the tax-exempt status and matching potential by US employers.

Why do Americans Use 401ks?

The United States relies on social security to help provide social benefits for retirees.

These individuals receive money from the government at mandated retirement ages based on their salaries and contributions during their time of employment.

To supplement this, Americans routinely have relied on 401ks in recent decades, especially with the rollback of many pensions.

A 401ks utilizes income taxes on pre-tax contributions and investment earnings in the form of interest and dividends are tax deferred.

Of note, the ability to defer income taxes to a period where one's tax rates may be lower is a potential benefit of the 401k plan.

This can create a misunderstanding however. For example, the ability to defer income taxes has no benefit when the individual is subject to the same tax rates in retirement as when the original contributions were made or interest and dividends earned.

Earnings from investments in a 401k account in the form of capital gains are not subject to capital gains taxes.

One of the main benefits of a 401k is the ability to avoid this second level of tax.

Relative to investing in other types of retirement accounts, higher amounts of income tax are paid but less taxes are paid overall with the 401k due to the ability to avoid taxes on capital gains.

At the time of writing, 401k plans in the US had over $6.4 trillion in assets.