A 401(k) plan is a defined contribution plan offered by many employers to help employees save for their retirement. These 401(k) plans are offered special treatment and have special requirements under the income tax code, and the name 401(k) actually refers to the section of the law that governs these types of plans.
A 401k plan allows individuals to save for retirement by contributing a percentage of their pre-tax income (up to a certain amount) every year. The percentage that can be contributed is set by the IRS and may be altered annually. It may also be affected by your income and age. For example, in 2010, the general maximum amount of money that could be contributed to a 401k plan was $16,500, but those over the age of 50 were also potentially eligible for additional "catch up" contributions.
Money that is contributed to your 401K is taken directly from your paycheck and you do not have to pay tax on that income (hence, the ability to invest pre-tax). In many cases, your employer also "matches" your 401k contributions up to a certain percentage. For example, many employers will match up to 10 percent of the money that you contribute to your 401k. When you contribute the money, it may be invested in a variety of different investment vehicles. Usually, mutual funds or a limited number of other investment offerings are available to you. You may select from among these investments offered by your employer and usually may move the money from one investment to another within the 401k account. You may not, however, withdraw money from your 401k prior to retirement age or you will be subject to penalties on the money that has been withdrawn.
If you are confused about your 401K or about the rules governing it, you should speak with a tax attorney or with your human resources department.