Background
Often, your employer will offer a retirement savings plan, and they're often called some terribly random combination of numbers and letters: 401(k), 403(b), 457(b), SIMPLE, SEP, TSP, etc. Generally, they operate in the same way. The differences have more to do with the employer (is it for-profit or non-profit, etc.) than the actual employee benefits, so don't get lost in the details here.
If your employer offers this benefit, your company onboarding documents will list details on this. You sign-up for these benefits through your employer/401(k) provider and most commonly, you will contribute to these investment vehicles as a % of your gross eligible wage (e.g. 5% of your bi-monthly paycheck, etc.).
**limitations of 401k, like age, etc.
The main benefits to workplace savings plans are:
If your employer may offers a match, it's free money
These investment vehicles have triple tax benefits
Sometimes, your employer will offer a match. Typically, they offer a match up to a certain % of your gross eligible wage (e.g. 4% match). In this example, what this means is that if you choose to contribute between 0-4%, they will put in the same dollar amount into your savings plan as you do. Anything past 4%, they won't match any more.
These employer savings plans have triple tax benefits:
Your annual IRS taxes are based on your taxable income, which does not count the amount you contribute towards your employer savings plans (even if it is a part of your gross income) - essentially, your income is lower in the eyes of the IRS
These investment vehicles are tax-deferred. Adding on to #1, you know that Uncle Sam is never not going to take every opportunity to tax you ;), so the government actually taxes you when you take money out. Any money you take out later will be added on to your taxable wages for that year, so keep that in mind. However, this is still considered a tax benefit because imagine you made $100,000 this year and contributed $20,000 to your 401(k). This means that you get taxed on $80,000 this year and when you take out $20,000 years from now when you retire (and don't have other income), you'll be in much lower tax brackets this year and in the future.
Any growth via investments in your workplace savings plans are non-taxable, whereas they typically are in other investment vehicles
Note that the IRS has dollar limits to how much a person can contribute to their workplace savings plan, so keep that in mind before you start contributing 50% of your income. The IRS can announce changes for every calendar year. What's annoying is that since IRS limits are dollar amounts, you have to pre-calculate what the highest % of your 401(k) eligible wages should be, before hitting that dollar limit. Tip: Employee matches do not count as part of the limit.
For example, let's say the IRS limit is $20,000 this year:
Gross Eligible Wage: $50,000
Employee Contribution Rate: 40% ($20,000 - IRS maximum!)
Employer Match: 5% (this match does not affect the IRS limit)
Total Employer + Employee Contribution this year: $20,000 (employee) + $2,500 (employer)
Gross Eligible Wage: $100,000
Employee Maximum Contribution Rate: 2% ($2,000 - below IRS maximum)
Employer Match: 3% (this match does not affect the IRS limit)
Total Employer + Employee Contribution this year: $2,000 (employee) + $2,000 (employer)
Note: this individual did not take full advantage of the Employer Match - free $1,000 annually!
*For some people, all of their gross wages are eligible and for some people, only a portion of gross wages will be eligible (sometimes commission, bonuses are not included at the discretion of your employer). An employees contribution rate will be based on the eligible gross wage.
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