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The Curious Bag
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A 401k provides many tax benefits over non-retirement accounts. For many people, a 401k is a great way to save for retirement while allowing their capital to grow tax free.
Pre-Tax Contribution
Qualified 401k plan contributions are made with pre-tax dollars. As a result, income tax and payroll taxes are not deducted from money contributed to the retirement account.
Tax-Free Growth
Money in a qualified 401k plan grows tax free. Taxes on dividends and capital gains are not collected when they occur.
Withdrawals
When money is withdrawn from a 401k plan, the money withdrawn is taxed as ordinary income because it was contributed on a tax-free basis and grew tax free within the retirement account.
Growth of Assets in Non-Retirement Investments
Taxes for dividends, interest and capital gains in non-retirement accounts are due during the tax year when they occur. They do not grow tax free as they do in 401k accounts.
Warning
If money is withdrawn from a 401k plan before age 59 1/2, the individual must immediately pay income tax on the amount withdrawn as well as suffer a 10 percent penalty.
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