Tax Advantages
Most retirement (the exception being most non qualified plans) plans offer significant tax advantages. Most commonly the money contributed to the account is not taxed as income to the employee, but in the case of employer provided plans, the employer is able to receive a tax deduction for the amount contributed as if it were regular employee compensation. This is known as pre-tax contributions, and the amounts allowed to be contributed vary significantly among various plan types. The other significant advantage is that the money in the plan is allowed to grow through investing without being taxed on the growth each year. Once the money is withdrawn it is taxed fully as income. There are many restrictions on contributions, especially with 401(k) and defined benefit plans that are designed to make sure that highly compensated employees do not gain too much tax advantage at the expense of lesser paid employees.
Currently two types of plan, the Roth IRA and the newly introduced Roth 401(k), offer tax advantages that are essentially reversed from most retirement plans. Contributions to Roth IRAs and Roth 401(k)s must be made with money that has been taxed as income, but after meeting the various restrictions, money withdrawn from the account is tax-free.
Read more about this topic: Retirement Plans In The United States
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