Your company's human resources group can provide you with the information about your 401(k) plan. Through automatic payroll deductions, you can usually contribute between 1% and 25% of your eligible pay on a pre-tax basis, up to the annual IRS dollar limit of $11,000 ($12,000 if you're age 50 or older in 2002). The maximum dollar limit for contributions represents a tax savings of $2,970 for someone in the 27% tax bracket.

Employer contributions, which are optional, typically come in the form of a company match. Most employers offer some type of a company match -- both as an incentive for employees to join the plan and as part of the overall benefits package. The match may be done either with company stock or cash and can range from 25% to 100% of your contribution to the plan, up to a company-set limit. You'll want to find out when the match is applied; it may be every pay period, but it could be quarterly or follow some other scheme.

Because your contributions are usually a percentage of your salary, which is more or less the same every pay period, you invest an equal amount every paycheck. This is called dollar-cost averaging, a much-touted tenet of smart investing. Over time it lowers the average cost of your fund or stock.

"Vesting" is a term that describes your ownership of your account balance. You are always 100% vested in your contributions to the 401k plan as well as any earnings on your contributions. However, company matching contributions and related earnings may vest according to a defined schedule. Don't expect to "own" all that money right away -- it may take up to five years until the company match is fully vested.

Why do contributions to a 401(k) plan provide a tax benefit? Before being taxed, your money is put into your 401(k) and allowed to grow along with your earnings. Your federal, state, and local taxes are taken out of your salary only after your 401(k) money has been taken out first, making your taxable income, and thus your tax bill, lower. That's why maxing out on your 401(k) contributions is an unbeatable tax saver.

Some plans also allow participants to make after-tax contributions. While these are taken after-tax and are nondeductible, the earnings grow tax-deferred until retirement when they are taxed like ordinary income.

Source: Quicken