Final answer:
A 401(k) is a defined contribution retirement plan where employers and employees can make contributions that are invested in various options, with tax-deferred benefits and portability across jobs. It is different from an IRA, which individuals set up independently of employers, but both aim to increase retirement savings through tax incentives.
Step-by-step explanation:
A 401(k) is an example of a defined contribution plan, which has largely supplanted traditional pensions and other defined benefit retirement plans. These employer-sponsored retirement plans involve a fixed contribution from the employer to the employee's retirement account, usually done every paycheck.
Employees can also contribute, and the combined funds can be invested in various investment vehicles. Such plans benefit from being tax deferred and are portable, which means employees can take their 401(k) plans with them even if they change employers. The appeal of a 401(k) also lies in its ability to potentially outpace inflation through investment returns, unlike fixed pension plans.
One important distinction to note is between a 401(k) and an Individual Retirement Account (IRA). An IRA can be established by an individual without an employer's involvement, whereas a 401(k) is a workplace-provided savings option with special tax benefits.
In both cases, taxes on contributions are deferred until withdrawal after retirement. Moreover, despite their growth and popularity, increasing savings in IRA and 401(k) accounts have not necessarily translated into higher overall personal savings rates in the United States, indicating changes in savings behavior or increased borrowing.