You fund 401(k)s (as well as other kinds of defined contribution plans) with "pretax" dollars, which means your contributions are taken out of your paycheck prior to taxes are deducted. That implies that in the event you fund a 401(k), you reduce the quantity of earnings you need to spend taxes on, which can soften the blow for your take-home spend. For instance, in the event you place $100 into your 401(k) every month, your paychecks may only get smaller sized by about $60-$80 monthly. (The precise quantity will differ based on your salary and tax bracket.)
So in the event you make a little contribution to a 401(k), or in the event you improve your contribution by 1% or so a year, probabilities are you will hardly even notice the distinction inside your spend checks, as well as your tax bill will probably be reduce.
You'll have to spend taxes ultimately obviously, but not till you retire. The IRS taxes all withdrawals at your ordinary earnings tax price.
But there is a catch: in the event you make withdrawals prior to age 59 ?, you usually need to spend a 10% early withdrawal penalty on leading of any taxes due. That may take an enormous chunk out of one's nest egg, and is generally a poor concept.
There is also a kind of 401(k) strategy known as the Roth 401(k), which provides a tax break that basically acts because the reverse from the conventional 401(k): You do need to spend tax in your contributions, but you will not need to spend any tax whenever you withdraw the cash in retirement. So all of the cash inside your account grows tax totally free.