Final answer:
In a 401(k) plan, contributions are tax deductible, and the income generated is taxable upon withdrawal at retirement, known as tax deferral. It is a type of defined contribution plan, where taxes on both contributions and gains are deferred.
Step-by-step explanation:
Regarding the tax implications of a 401(k) plan, the correct answer is that the contributions are tax deductible, and the income generated by the account is taxable when it is withdrawn at retirement. This is known as tax deferral. Specifically, for a 401(k) plan, the funds an employee contributes are not subject to income tax at the time of deposit. Instead, both the initial contributions and the investment gains are taxed when the employee takes distributions, typically during retirement. This tax arrangement encourages saving by deferring taxes until the funds are withdrawn.
A 401(k) is an example of a defined contribution plan, where the amount of the retirement benefit depends on how much money is contributed to the plan and the performance of the investments. Unlike pensions which are defined benefit plans that provide a predetermined amount upon retirement, 401(k)s give employees control over how their retirement savings are invested and the flexibility to carry the plan to the next employer should they change jobs.