Salary deferral in a 401(k) plan refers to an agreement where an employee elects to have a portion of their salary paid into a 401(k) plan, instead of receiving it directly as cash compensation. This portion of the employee’s income is not included in their taxable income for the year in which it is deferred. It is instead invested and taxed at the time of withdrawal, typically during retirement when the employee may be in a lower tax bracket.
The deferred money is usually invested in a selection of funds provided by the 401(k) plan, which can include stocks, bonds, mutual funds, and other assets. The main advantages of salary deferral are the tax benefits, as contributions are made pre-tax, and the potential for growth through investment returns over time. Additionally, many employers offer matching contributions to the employee’s 401(k) plan up to a certain percentage, which can significantly enhance retirement savings.