If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content


401(k)s (and how they compare to IRAs). Created by Sal Khan.

Want to join the conversation?

  • blobby green style avatar for user wcoq458
    why is this called a 401k?
    (18 votes)
    Default Khan Academy avatar avatar for user
  • male robot johnny style avatar for user Andy Hernandez
    Can someone elaborate on the concept of borrowing from a 401(k), how to pay that money back, and how that differs from an early withdrawal which would be subject to penalty. Also, would it be possible to stop participating in the 401(k) and roll it into a Roth IRA and take out the principle without penalty?
    (6 votes)
    Default Khan Academy avatar avatar for user
    • leaf blue style avatar for user chrisg1809
      In general, participants in 401(k) plans may borrower from their account. The maximum amount permitted is lesser of (a) $50,000 and (b) 50% of the balance of your 401(k) account. Generally, repayments to the plan occur via automatic deductions from your pay (performed by your employer). Repayment begins in the first pay period after the loan is made.

      Unless the proceeds of the loan are used to buy a home, the maximum maturity of the loan is 5 years. If buying a home, the term of the loan can be much longer.

      The primary difference between a 401(k) loan and an early withdrawal is that the loan does not trigger a tax event. Assuming you repay the loan, you will not pay any taxes on the amount of the loan or suffer any penalty. In an early withdrawal, you will pay a tax on the amount withdrawn in the year of the withdrawal PLUS a 10% penalty which is huge.

      If you stop working for the employer you had when you took out the loan, the loan will normally become due in 60 days. This is true regardless of the reason that your employment ended. If you don't repay the loan in those 60 days, the remaining balance on the loan will be treated as though it were an early distribution, subjecting you to tax and penalties on the unpaid amount.

      Generally, I'd recommend that people avoid 401(k) loans unless they're facing a dire financial emergency.

      Generally, it is possible to roll a 401(k) account into a normal IRA and then convert the IRA into a Roth account.

      These issues can be a lot more complex that what I've explained. It's a good idea to find a tax adviser if you're seriously considering a 401(k) loan or a Roth rollover.


      (15 votes)
  • blobby green style avatar for user maria victoria acuna
    What happens if the person dies before the Traditional, Roth or 401k's can be withdrawn?
    (6 votes)
    Default Khan Academy avatar avatar for user
  • leaf green style avatar for user FinallyGoodAtMath
    What about the self-employed? What are some plans for self-employed retirement accounts and how are they different?
    (5 votes)
    Default Khan Academy avatar avatar for user
  • blobby green style avatar for user ragoldbeck
    If I start investing in a 401 (k) at this job, but leave after only a few years- what happens to the money. Can I continue my 401(k) at another job?
    (4 votes)
    Default Khan Academy avatar avatar for user
    • male robot hal style avatar for user Andrew M
      You can roll over the 401k into an IRA (you would probably want a Roth IRA)
      Alternatively, your new employer might let you roll into their 401k .
      But usually the first option is better because you retain more control over the money.
      You have to do the rollover the right way to avoid a tax penalty. The company where you are holding the IRA will advise you how to do it right. It's very routine and not hard to do.
      (5 votes)
  • starky sapling style avatar for user Audrey
    what is a good amount of money to start saving per week? What is one thing that really helped you to save, i just need help getting started
    (4 votes)
    Default Khan Academy avatar avatar for user
    • aqualine tree style avatar for user David Alexander
      Rather than an amount, you might focus first on a percentage. When you develop the habit over a period of about... 12 weeks at say... 5%, then kick it up to 7.5% for 12 weeks, and if that's doing you good, kick it up again. Get into the habit, slowly, and the habit will do you good.
      (5 votes)
  • piceratops ultimate style avatar for user Rayce Wiggins
    Is the limit the maximum amount of money you can put towards your 401k per year?
    (5 votes)
    Default Khan Academy avatar avatar for user
  • leaf green style avatar for user Coastman
    What is the difference between a 401(K) and a Roth 401(K). Witch one is better?
    (4 votes)
    Default Khan Academy avatar avatar for user
    • leaf blue style avatar for user Aaron Y
      Contributions to a traditional 401k account aren't subject to federal and state income taxes for the year during which you make the contributions. When you withdraw your accumulated contributions plus investment earnings in retirement, you'll pay ordinary income taxes at the federal and state income tax rates applicable to you at that time.
      It's the other way around with a Roth 401k account. Contributions are subject to federal and state income taxes in the year you make the contributions. Withdrawals of accumulated contributions and investment earnings at retirement aren't subject to income taxes.

      Which one is better depends on your situation. Here's an example I made up for another answer:

      A person makes $10k/year and pays 5% in taxes. He invests into a traditional and starts saving $250/year on taxes. When he turns 59, 40 years later, he finally gets promoted and his new income lands him in the 25% tax bracket. Now, if he withdraws from his traditional, he has to give up 25% of it to taxes when he only saved 5% of it. So if he saved up a total of $200k, he now has to give $50k to taxes! (but saved merely $10k from his taxes deductions over the years). He actually lost $40k by investing in the traditional. On the other hand, if he had invested in a Roth, we can flip those numbers: he would have paid $10k in taxes over the years and saved $50k by not having any tax on his $200k when he finally withdrew, getting to keep that extra $40k instead.

      Basically: if you're pretty poor now (and yet can still invest your money) and plan on getting promoted later in life, go with a Roth. If you're not that optimistic about job promotions in the future, invest in a traditional.
      (4 votes)
  • blobby green style avatar for user janmj2
    how long can you leave your money in your 401k after you retire
    (2 votes)
    Default Khan Academy avatar avatar for user
  • leafers ultimate style avatar for user Jorge Alexander Medina
    It sounds to me like you can use both IRAs and 401ks to "game the system" so to speak, and get into a lower tax bracket than you would without them. The way I understood this was as follows:
    1. You earn some money (pre-tax income).
    2. Out of that money, some is set aside for either IRAs or 401ks
    3. Income taxes are then calculated and deducted from the remaining money.
    4. You get your money (post-tax income).

    Is this correct?
    (2 votes)
    Default Khan Academy avatar avatar for user

Video transcript

What I want to do in this video is to talk a little bit about 401(k)'s which you probably at minimum have heard of. Just from the get-go, just to put some structure in your mind of what this really is is it's very similar to a traditional IRA. It's very similar to a traditional IRA and the ways that they're the same is that you defer you taxes. You put money in on a tax deferred basis. Let me put it this way, you put pretax money in. The money can grow inside of either the 401(k) account or the traditional IRA account untaxed. Let me write that, money grows in account untaxed and then you can withdraw it, you can withdraw the money. You can withdraw or start getting distributions from the account after age 59-1/2. That's essentially when you're going to start retiring, when you're going to need the money. When you withdraw after the age of 59-1/2 you will then pay income tax. This is what people are talking about when they talk about deferring taxes. You're not getting out of the taxes, you're just pushing off the date that you're going to have to pay the taxes. For a lot of people this might be useful because while you are making money, you might be paying at a fairly high incremental tax rate but then once you're retired you have a much lower, you'll have a much lower, I guess you'll be in a much lower incremental tax bracket and so your total overall tax bill might be lower. Also, maybe something happens just in terms of what the government does, in terms of how they charge taxes. In general, if you had to pay 50 cents 20 years in the future versus 50 cents today, just present value of money tells you that that 50 cents is going to be worth a lot less in the future or the present value of it is a lot less. That's some reasons to defer. Of course, you're not just going to pay on what you put in, you will then also pay income tax on what you've put in and whatever grew. You'll pay income tax on total disbursals. In both cases, you have to start taking disbursements from your account by 70-1/2. Penalties, let me write it this way. Penalties, if you don't withdraw or you don't start withdrawing some of your funds by 70-1/2. There's some special cases if you're working and all these type of things. Now, what's happens if you withdraw before age 59-1/2? Before 59-1/2. So far, everything I've listed is true of both 401(k)'s and traditional IRAs. If you withdraw before 59-1/2, you are taxed on withdrawal. On top of that, there's a 10% penalty on all the funds you receive. 10% penalty. This is what you have to think about unless if you just say, "Oh, I'm always just going to max out "my traditional IRA or 401(k)." You got to make sure they're not going to want that money before 59-1/2 because you might be facing this 10% withdrawal. These are all the cases that are the same. The question is why do they both exist? Why is there something called a traditional IRA and why is there something called a 401(k)? They both seem like a pretty good way for me to defer taxes, get earnings on my investment in a taxed deferred way and then pay it some future date and they both force me to make sure or they strongly suggest that I shouldn't take out my money before 59-1/2. The ways that they're different, let's focus on the differences, the differences between the 2. One is 401(k)'s have a higher limit and if you're focused on 2010, but these numbers keep changing. In 2010 the 401(k) limit is $16,500 and that's for just what you contribute into your 401(k). This is for a 401(k). While the IRA limit is $5,000. This is an IRA. One; 401(k), you can just participate with more money. Actually, in both of these cases, as you approach your retirement, after the age of 50. Let me put that in the same thing just so we're comprehensive. Another similarity is that you can accelerate or have higher, you could have higher, I guess, deposits into your account, accelerate after 50. Which just means you can put more money than these limits that I have right here. These are limits before you're 50, after 50, between 50 and 59-1/2 when you can start withdrawing. You can put a little bit more money in that and these are constantly moving targets. The general idea is that you can put more money inside of a 401(k). Now, the other difference is that a 401(k) tends to be organized by your employer. 401(k) organized by employer. Just, from your point of view, that means 2 things, One is the employer will often specify the potential investments. Specifies investments. They'll actually run the 401(k) account for you. Normally it will be held by someone else but it will be for your company, for company x. The company gets to decide the universe of investments that you might be able to invest in. The other thing, because it's run by the employer, the employer might match. Which means for every dollar you put in, they'll put another dollar even they might go above matching and you could actually go up to, I think the current limits are approaching $50,000 for the total of the employee and employer match. You can actually get a lot of, I guess you could think of it, leverage from putting in into a 401(k) if you have a very generous employer. The other difference, this is really a superficial difference because it's just what you see, is that with the 401(k) the money will be taken out of your paycheck, you will never see it. Taken out before paycheck. While with a traditional IRA, you will take the money, invest it into a traditional IRA account and when you report your taxes it will be reported as a tax deduction and so you won't have to pay tax on it. Functionally they're the exact same thing. When you think about the pros and cons, if you have a 401(k), if the option is available to you, it's a pretty good option. You're going to have higher limit. You're going to have a higher limit right over here and your employer might match it. Then the other thing, and this doesn't come into plays a lot, but there's also the option of borrowing from a 401(k) without penalty. Borrowing from a 401(k) but you have to pay back interest to the 401(k) account if you did that and you cannot do that with a traditional IRA. Now, when you're looking at all these you're like, "Whoa! "Why would anyone ever want to do a traditional IRA?" There's a couple of things. One; you could do both. Or the other thing is with traditional IRAs you have much more flexibility on where you want to invest. Maybe your company says you can only invest in us, you can only invest in that company's stock. In traditional IRAs you can invest in anything. Hopefully that clarifies things a bit for you.