401 K Retirement Plan
A 401 K retirement plan gets its name from a section of the US Internal Revenue Code. 401ks benefit employers and employees, letting everyone save for the future. Typically, employees must contribute to their 401K, and they receive a contribution. Two basic 401K types exist, traditional and Roth.
Traditional
With a traditional 401K Retirement Plan, employee contributions come out of gross or pre-tax income. This structure reduces the contribution amount and reduces the employee’s taxable income. At the year’s end, your accountant can take that and use it as a deduction. No taxes are due on the contributed money or the investment earnings until withdrawal. Usually, people keep their money inside the investment to lower taxes.
Roth 401K
A Roth 401K is the same as a traditional one, but contributions are from post-tax earnings. Consequently, there is no deduction in the year of the contribution. When the money is withdrawn, there are no additional taxes owed on it. So, in essence, you paid the total taxes owed on the money right up front.
Contributing to a 401K
401Ks are a type of defined contribution plan. Employees and employers can make contributions up to the IRS-specified dollar amount.
Defined-contribution plans are an alternative to pensions or defined-benefit plans.
2022 Contribution Limits
The maximum amount that can be added to the account in a year is fixed. It usually adjusts with inflation, but the limit in 2022 on employee contributions is $20,500. If you are over 50, you can add $6,500 for $27,000 total.