Investing Retirement Planning 401(k) Plans Investing Through Your 401(k) A Beginner's Guide to the Different Types of 401(k) Plans By Joshua Kennon Joshua Kennon Twitter Website Joshua Kennon is an expert on investing, assets and markets, and retirement planning. He is the managing director and co-founder of Kennon-Green & Co., an asset management firm. learn about our editorial policies Updated on December 1, 2022 Reviewed by Andy Smith Reviewed by Andy Smith Andy Smith is a Certified Financial Planner (CFP), licensed realtor and educator with over 35 years of diverse financial management experience. He is an expert on personal finance, corporate finance and real estate and has assisted thousands of clients in meeting their financial goals over his career. learn about our financial review board Fact checked by Julian Binder Fact checked by Julian Binder Julian Binder is a fact checker, researcher, and historian. They were the recipient of the North American Studies Book Prize (2016, 2017), and they have previous experience as an economics research assistant. They have also worked as a writer and editor for various companies, and have published cultural studies work in an academic journal. As a fact checker for The Balance, Julian is able to utilize their experience as an editor and economics research assistant. Their role as fact checker is to review articles for accuracy, update data as needed, and verify all facts by citing trusted sources. learn about our editorial policies In This Article View All In This Article How Does the Standard 401(k) Plan Work? The Roth 401(k) The Small Business 401(k) Reducing Risk What Happens to Your 401(k) When You Leave Your Job? Frequently Asked Questions (FAQs) Photo: Hinterhaus Productions / Getty Images A 401(k) plan is offered by employers with the goal of helping you save for retirement. It's often part of a larger benefits package. There are many reasons to use a 401(k) as a savings tool. It allows you to divert some of your earnings to a special account and avoid having it taxed along with the rest of your income. And many employers offer a matching program. They'll also deposit money into your account to match the money you put in, up to a certain amount. These features alone will help your savings grow at a faster rate than if you were to use a standard savings account. There are several different types of 401(k) plans, each with unique pros and cons. They include the traditional 401(k), a self-directed plan, a safe-harbor plan, a SIMPLE 401(k), a Roth 401(k), and a tiered profit-sharing plan structure. Key Takeaways The Roth 401(k) uses after-tax dollars, and they grow tax free.Self-employed 401(k) plans, also known as "solo 401(k)s," are for small business owners and independent contractors.You can avoid penalty taxes by moving the money into a rollover IRA if you leave your job and have to take your money out of your 401(k).You can incur fees if you take premature withdrawals, and you may have to enter into a repayment plan. How Does the Standard 401(k) Plan Work? These plans are designed to help you build wealth over time. You'll set a dollar limit or a percentage of your pay that you want to contribute to your account each pay period. This is why you might also hear 401(k)s referred to as "defined contribution" plans. The money comes directly out of your paycheck before taxes are calculated on the balance. You might be saving more than you put in if your employer offers a match program. Your employer will choose a plan provider that will build wealth for you by investing the funds you've contributed in any number of assets. These can include mutual funds, stocks, index funds, and real estate investment trusts (REITs). You may be able to choose how your funds are invested in some cases, or at least how safe you'd like the account managers to be with your money. The perks are clear, but there are downsides as well. These plans are designed to work over the long term, so it's generally not advisable to take money out. You can incur fees for early withdrawal if you do. And those taxes that you didn't have to pay when you put the money into your account will come due later when you take withdrawals. Note The Internal Revenue Service (IRS) has rules about how much you can contribute to a 401(k), and the limits can vary from one year to the next. The Roth 401(k) A Roth 401(k) is a special type of plan that has many of the same benefits of a Roth IRA. The money you add to the plan comes from after-tax dollars. Contributions to Roth 410(k) plans count in your gross income each year, so you don't get a tax break when you add money. But you won't pay a penny in income tax or capital gains tax on that money, even if it grows to tens of millions of dollars by the time you retire. Note Standard 401(k) contributions are tax deductible, and you only pay taxes when the money is withdrawn. The Small Business 401(k) A self-employed 401(k), also known as a "solo 401(k)," can be a great choice for small business owners or those who work for themselves. It has many features that may make it more attractive to small business owners than the simplified employee pension individual retirement account (SEP-IRA). Owners make contributions with pre-tax dollars, which are allowed to grow tax free until they're withdrawn during retirement. As with all 401(k) plans, the IRS has limits on the amount a self-employed person can contribute to the plan. Many people qualify for a solo 401(k) without even being aware of it. With its larger contribution limits and wider range of qualifying investments, this type of plan might help you reach your retirement goals sooner if you work for yourself and have no employees. Reducing Risk Most 401(k) accounts give you a degree of control over how much you invest, how you choose to use these funds, and when you can or must withdraw. But there are risks that come with certain actions, so it's important to know how they will affect your long-term savings goal. Should You Max Out Your Contributions? It can be risky to put too much money into your 401(k) account at any one time. First, make sure that your budget can handle it. It can be easy to be swayed by the changes you see in your earnings if this type of account is new to you, whether that's your reduced paycheck or the growth in your 401(k). Most investments gain over time, so it's wise to start slowly and steadily. Should You Take Money Out of Your Account? It can be tempting to withdraw funds from your 401(k) account if times are tough and you're struggling to make ends meet. But not every account allows this, and those that do have strict rules. Your contributions will likely pause. You may incur fees, and you may be subject to a harsh repayment plan. Even though it's your money, taking it out early is actually more like a loan than a withdrawal. Of course, there are times when using the funds in your 401(k) account might be the best or only option you have. Just be sure you understand the risks. Should You Adjust Your Contribution? Many people wonder whether they should stop adding money to their 401(k) accounts when the market is down, or if their job is in danger. But a 401(k) account is, in fact, one of the safest places your money can be. Pausing contributions to your 401(k) can be a costly mistake. What Happens to Your 401(k) When You Leave Your Job? You have a choice to make about your 401(k) if you leave your job. You'll be subject to taxes if you close the account and withdraw the funds. The best option is often to "roll it over." The Rollover IRA is a special account that allows you to move the money in your 401(k) into it and it will protect it from taxes. Frequently Asked Questions (FAQs) Are there any restrictions as to who is eligible for a 401(k) plan? If you work for a government agency or for a nonprofit, you won't be eligible to save that particular income to a 401(k) plan. But you might be able to invest in something known as a 403(b) plan instead. Should you invest in your company's stock? Your employer may offer you a better deal on stock options than it would offer the public at large, and that potential is worked into many 401(k) plans. But how do you know whether your employer is a McDonald's or a Walmart and not an Enron or a Worldcom? The first two made their employees very wealthy, whereas the other two suffered absolute wipeouts. The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. IRS. "Hardships, Early Withdrawals, and Loans." IRS. "401(k) Plan Overview." IRS. "Retirement Plans FAQs on Designated Roth Accounts." IRS. "One-Participant 401(k) Plans." IRS. "IRA FAQs - Rollovers and Roth Conversions." IRS. 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