Since 1981, American workers have had the opportunity to save for their retirements with at type of employer-sponsored plan know as a 401(k).

The term “401(k)” refers to the chapter of the Internal Revenue Service tax code that enacted the plan after it was legislated by Congress. For-profit companies can sponsor 401(k) plans for their employees. A similar scheme, known as a 403(b) retirement plan, is available for employees of not-for-profit corporations such as churches and community organizations.

Workers can establish a 401(k) account only if their employers will sponsor such a plan, because the savings and investment plan works through payroll deduction. Each employee can authorize his or her employer to deduct a certain amount of money from each paycheck and send it to the plan administrator as an investment. The deduction is known as a “contribution” or in some cases, a “deferment” (since the employee is “deferring” a portion of his or her pay into savings).

This deduction is taken out of employees’ salaries and wages before federal income taxes are calculated, so there can be a significant up-front tax savings to participating in a 401(k) plan. For example, if an employee earned $500 a week and allocated a 10 percent contribution to his or her 401(k) or $50, then the employee would pay federal income taxes only on the remaining $450 in weekly pay.

Looked at another way, investing in a 401(k) plan benefits an employee in three ways:

• • It lowers taxable income, providing an immediate break on federal income tax.

• • It puts more money to work in investments to generate future income.

• • The investor doesn’t pay income tax on the assets until they’re withdrawn in retirement, when most people are in a lower tax bracket.

Employer-sponsored 401(k) plans are typically administered through investment brokerage firms. These firms offer a variety of ways to invest the savings so that it will accrue interest and grow over a period of time. The employee chooses which types of investments into which his or her contribution will go. These include mutual funds, stocks and bonds. Often an employee will elect an investment based on the amount of risk involved. For instance, a younger employee who has more time to save for retirement may choose to put the money into stocks or mutual funds that are riskier, but have a higher rate of return. Meanwhile, an older employee, with less time until retirement, may be more comfortable placing his or her savings into bonds or mutual funds that might pay less in interest, but are safer in terms of risk.

In addition to the employee’s contributions, an employer can opt to “match” an employee’s contributions in part or in whole. In some cases, this match takes the form of profit-sharing; in the years when there is no profit, the employer makes no contribution to the employees’ retirement savings plan. Employers are responsible for keeping track of the employees’ contributions to the plan and for seeing that the plan is properly administered. The IRS holds the employer at fault if something goes amiss with the administration and reporting practices.

Some companies offer employees the option to purchase the company’s stock as part of their 401(k) plans. Recent experiences have shown that this can be a more risky strategy than some first suspect, such as when employees with failed businesses such as Enron lost their entire retirement savings because the company’s stock became worthless.

Fortunately, the employee has control of where his or her money is invested in most 401(k) plans. A less-common form of the 401(k) is the trustee-directed plan, in which the employer appoints trustees who decide how the plan’s investments will be allocated. Often this trust committee is composed of some of the company’s employees.

Even if they leave a company that sponsors a 401(k), the employee’s account remains active for life, unless he or she chooses to convert the employee-sponsored account to an Individual Retirement Account known as an IRA. Converting an account in this way is called a “rollover.” Either way, the employee must begin withdrawing savings from the account starting April 1 of the year after becoming 70-1/2 years old, or on April 1 of the calendar year after retirement, whichever date is later.