A 401(k) plan is a type of retirement plan which is named for a section of the tax law that allows employees to contribute a portion of their compensation, before income taxes, to a company-sponsored retirement plan. The amount the company withholds from your paycheck is called a 'deferral'.
401(k)s are employer-sponsored retirement plans. The contributions you make come out of your paycheck usually before taxes. That means your taxable income is lower and your tax burden is decreased.
Plus, since the money is coming out of your paycheck before you get it, you'll never even see it to miss it!
Many 401(k) plans give employers the option of matching a portion of the amount you invest. For example: your annual compensation is $60,000 a year and contribute 8% to your 401(k) plan, your annual contribution would be $4,800. If your employer matches that amount up to 3% of your compensation, that's an additional $1,800 going into your retirement savings. It's almost like free money!
When you contribute to your 401(k) account, the money comes out of your paycheck before federal and most states' income taxes are assessed. This means that you will pay lower income taxes than you would have paid if you had not contributed to your 401(k) plan during the year. Your contributions are invested and start earning interest and capital gains on a tax-deferred basis. When you start withdrawing money from your account, usually at retirement when you may be in a lower tax bracket, you will pay regular income taxes on the contributions and earnings you withdraw.