How does a 401(k) earn money?

The savings in a 401(k) can grow in four ways: payroll deductions, matching contributions, investments, and compound growth.

A payroll deduction is the chosen amount of a participant’s paycheck that is removed and placed in the 401(k) so it can grow overtime.

Matching contributions are optional, extra percentages of money that employers may choose to put into employee accounts for employee benefit.

Once all contributions are collected, professional investors allocate the fund to selections of index funds, mutual funds, or exchange traded funds. Each placement generates an expected return of money back.

As more money grows from contributions, matching, and investments, a mathematical principle called compounding comes into play. As cash increases by a certain percentage each year, although the percentage does not change, the amount added to the account from contributions and investments grows. That means as the amount in the account rises, growth does too!